Overnight indexed swaps up as rate cut delay looms

The rates on overnight indexed swaps (OIS) have started rising, as markets anticipate that a reversal in the monetary tightening cycle would not happen anytime soon. The Reserve Bank of India (RBI) is expected to maintain the policy rate at the current level in the third quarter review of monetary and credit policy on January 24.

The one-year and five-year swap rates rose by 12 basis points each on Tuesday, compared to yesterday’s closing levels. Swap rates have increased by 20-30 basis points across tenures since the beginning of this month.

“Rate cuts were expected earlier, but these may not happen before April,” said N S Venkatesh, head of treasury, IDBI Bank. He added the tight liquidity conditions seemed to be playing on market sentiments.

The central bank has raised the policy rate by 375 basis points since March 2010 to clamp down on high inflation and inflationary expectations. Data from the wholesale price index (WPI) suggest while food inflation has cooled, primarily owing to a high base effect, core inflation continues to be stubborn. Headline inflation eased to 7.47 per cent in December from 9.7 per cent in November. However, core inflation eased only marginally to 7.7 per cent from 7.9 per cent a month ago.

“The upward risks to WPI inflation still persist, as manufactured articles inflation, as well as fuel group inflation, remains elevated. Thus, RBI is unlikely to cut the policy rate before April,” said Arun Singh, senior economist, D&B India. He expects WPI to moderate slightly from the current levels and hover in the range of 6.9-7.1 per cent in this month.

In the mid-quarter review of monetary and credit policy, RBI said inflation could quickly recur due to both supply and demand forces. The central bank expects inflation to cool to seven per cent by the end of the current financial year.

In November, growth in industrial production rebounded to 5.9 per cent from negative 4.7 per cent in October, reflecting economic activity was still holding strong, despite the slowdown.

Yields on the benchmark government bond eased to 8.19 per cent from 8.5-9 per cent levels on hopes that RBI may opt for monetary easing steps in the upcoming policy review. Bond purchases by RBI through open market operations also helped bring down yields.

Tracking the movement in the yields on government bonds, rates on five-year OIS had softened to 6.8 per cent levels a month ago. However, the recent data on inflation dimmed hopes of early rate cuts.

Going forward, OIS rates may continue to rise till the announcement of the third quarter policy review. “Rates may harden by another 25 basis points because of the positive carry on spreads. After that, it would depend on RBI’s policy stance,” said a treasury official of a public sector bank.