Bond yields jump as RBI unexpectedly leaves rates steady

MUMBAI (Reuters) - Indian bond yields jumped sharply on Wednesday while shares fell after the central bank unexpectedly kept the key policy repo rate unchanged, prompting a sudden cutting of long positions across the board.

The Reserve Bank of India cited concerns about inflation and global markets in deciding to keep the repo rate at 6.25 percent, even as the cash shortage sparked by a move to ditch higher value banknotes threatens to hit economic growth.

The decision was a surprise: a majority of the 56 analysts polled by Reuters had expected a rate cut of at least 25 basis points, though 18 had forecast policy would remain unchanged.

Bond investors had been even more sanguine about rate cuts, with benchmark 10-year bond yield falling to a 7-1/2 year low late last month on expectations for aggressive rate-cutting by the RBI.

"Very few people had expected no change. Market was mega long as all state-run banks had liquidity, traders were long and so were mutual funds. So the positioning was extreme on one-side, which lead to the sharp reaction," the head of the fixed income and currency trading desk at a foreign bank said.

The benchmark 10-year bond yield was up 23 basis points at 6.40 percent from levels before the RBI decision and compared with its close of 6.20 percent on Tuesday.

The decision erased early gains by domestic shares, which ended the day weaker. The broader NSE index closed down 0.5 percent after being up 0.5 percent before the central bank announcement.

The RBI said it would need to assess the economic data to determine its policy stance, saying it expected the impact from the measures to ditch India's higher banknotes would ebb as new notes come into circulation.

The central bank had also cited concerns about the potential fallout on emerging markets from expected rate hikes from the U.S. Federal Reserve, starting at its policy meeting next week.

"It is difficult to say at this point whether there will be a rate cut in the next (RBI) policy meet because that will again be a function of how demonetization has played out," said Varun Khandelwal, managing director of Bullero Capital.

"I think the RBI would prefer to see what the Fed does, and if the Fed is not very hawkish, they will probably cut (rates) at the next meet."

The next policy meeting is Feb. 8.

(Reporting by Swati Bhat; Editing by Richard Borsuk)