Bonds see biggest gain in 2-1/2 weeks as RBI trims auction size

By Swati Bhat

MUMBAI (Reuters) - Government bonds gained on Monday, sending yields down by the most in two-and-half weeks, after the Reserve Bank of India (RBI) trimmed the size of this week's debt sale while also approving the transfer of its surplus profits to the government.

Traders also said sentiment improved after the central bank announced its first-ever one-day variable rate overnight repo auction for 50 billion rupees earlier in the day. The auction comes a week after RBI Governor Raghuram Rajan said the central bank was considering shorter-dated term repos.

The focus will now shift to consumer price inflation, due on Tuesday, which is expected to have accelerated to 7.40 percent from 7.31 percent in June, according to a Reuters poll.

"The CPI data tomorrow is going to be the key factor to watch. I am expecting CPI to come below 7 percent which will be positive for the market," said Harish Agarwal, a fixed income trader with First Rand Bank.

"Market will however continue to remain rangebound with a downward bias in yields. New 10-year is expected to hold in a 8.50 to 8.65 percent range," he added.

The benchmark 10-year bond yield ended down 3 basis points at 8.82 percent, it largest single-day fall in yields since July 23.

The new 10-year bond yield ended down 5 bps at 8.59 percent.

Gains came after the Reserve Bank of India said it will sell 80 billion rupees (1.31 billion) of government bonds on Aug. 14, much lower than the originally-scheduled 140 billion rupees.

The RBI did not provide a reason for the cut but it came before the RBI said on Sunday its board has approved the transfer of a surplus profit of 526.79 billion rupees ($8.62 billion) to the government for the year ended June 2014, potentially reducing the need for proceeds from the auction in the very near-term.

In the overnight indexed swap market, the benchmark 5-year swap rate ended 1 basis point lower at 8.12 percent while the 1-year rate also ended 1 bp down at 8.48 percent.

($1 = 61.1850 Indian rupee)

(Editing by Sunil Nair)