Bonds post sharpest monthly gain in 1-1/2 years on rate cut hopes

By Gaurav Pai

MUMBAI (Reuters) - Indian government bonds posted their best monthly gain in 18 months on hopes easing inflation would allow the country's central bank to start trimming key policy rates earlier than expected.

The gains came on a day when the Bank of Japan surprised financial markets by significantly expanding its massive stimulus programme, reigniting hopes the global liquidity situation would continue to remain easy.

The 10-year bond yields have fallen 24 basis points this month, its steepest since May 2013, on strong demand from foreign investors and continued expectations of a rate reduction.

Foreign portfolio investors into Indian debt have bought nearly $2.8 billion so far in October.

"We believe inflation will soften in December, although a spike during Jan to March cannot be ruled out," said Soumyajit Niyogi, analyst, interest rate, SBI DFHI, a primary dealership in Mumbai.

"We expect a rate cut in early 2015, although one in December cannot be ruled out."

Fall in global oil prices also helped sentiment. Brent crude oil fell more than a dollar towards $85 a barrel on Friday as a firmer dollar and a well-supplied oil market pushed the benchmark towards its steepest monthly decline since 2012.

The benchmark 10-year bond yield closed at 8.28 percent on Friday after hitting 8.25 percent, a low it had touched on Aug. 22, 2013. The yield ended at 8.29 percent Thursday.

India's five-year swap rate ended steady at 7.50 percent, while the one-year rate fell 2 basis points to 8.08 percent.

(Editing by Biju Dwarakanath)