Sensex, bonds extend falls as rate-cut hopes wane

MUMBAI (Reuters) - The BSE Sensex fell more than 1 percent, while benchmark 10-year bond yields rose to three-week highs on Wednesday, as a forecast for India's first drought in six years and a cautious statement on inflation from the Reserve Bank of India (RBI) soured sentiment.

The losses come even after the RBI cut interest rates on Tuesday as investors were spooked by its cautious statement tying any additional monetary easing to food prices.

Less than two hours after the RBI issued its policy review statement, India cut this year's monsoon forecast to 88 percent of the long-term average, raising fears of the first drought in six years.

Sentiment was further hit on Wednesday after the HSBC Services Purchasing Managers' Index survey showed the nation's dominant services industry contracted last month as firms raised prices at their fastest pace in a year.

"The monsoon situation has presented a double whammy. It's clear that the demand could collapse, especially rural demand," said Daljeet S Kohli, head of Research at IndiaNivesh Securities.

"Now there's also a worry that a weak monsoon will also hurt the fiscal balance due to relief packages for affected areas."

The benchmark BSE Sensex was down 1.3 percent at 1:45 p.m., heading for its second consecutive loss after hitting its weakest since May 7 earlier in the session. The broader Nifty was down 1.2 percent.

Lenders were among the leading losers, with State Bank of India down 3.4 percent.

Among other losers, cigarette maker ITC was down 5.3 percent as the stock turned ex-dividend on Wednesday.

Tata Motors fell 4.6 percent on continued worries about the company's sales in China.

Bond markets were also reeling from waning hopes about rate cuts. The benchmark 10-year bond yield rose 4 basis points to 7.97 percent, after earlier rising to as high as 7.99 percent, a three-week high.

(Reporting by Himank Sharma; Editing by Subhranshu Sahu)