Bonds plunge on rate hike fears

MARKET ROUND-UP

The 10-year bonds fell, sending yields to near the highest in five months, on forecasts the central bank will increase interest rates this week to curb inflation stoked by record economic growth.

Ten-year yields this month rose the most since June before the January 31 policy review of the Reserve Bank of India, which lifted its lending rate by a per cent in 2006 to 7.25 per cent.

Ten of 16 economists surveyed by Bloomberg News forecast the central bank will raise the rate to 7.5 per cent. Yields have risen in the past two months, reversing more than half their decline in the previous four months.

"The bond market is awaiting the RBI policy review and has more or less priced in a quarter-point increase in interest rates,'' said K P Suresh Prabhu, chief bond trader at HDFC Bank based in Mumbai. "The central bank will act to slow inflation, which has risen above its target range, and curb record credit growth.''

The yield on the benchmark 8.07 per cent note due January 2017 rose 2 basis points, or 0.02 per cent to 7.9 per cent as of the 5:30 pm close in Mumbai, according to the central bank's trading system.

It rose 28 basis points this month, following a 20 basis points gain in December. The price, which moves inversely to the yield, fell 0.18, or 18 paise, to Rs 101.14. The 10-year bond yield may move closer to 8 per cent in the coming days, Prabhu said.

"Underlying inflationary pressures remain,'' the central bank said today in a report released before the quarterly monetary policy statement. The inflation rate was 5.95 per cent in the week ended January 13, according to government data, higher than the 5 per cent to 5.5 per cent range targeted by the central bank. A week earlier, the rate had risen to a two-year high of 6.12 per cent.

Finance Minister Palaniappan Chidambaram wants to slow inflation to less than 4 per cent as his Indian National Congress party prepares for seven state elections this year.

Record growth in salaries and bank loans is spurring demand for manufactured and agricultural products in the country, fanning inflation. "All the negatives are factored in at the moment, and we don't see yields rising much beyond these levels,'' said Rajesh Babu, a bond trader at state-owned Andhra Bank in Mumbai.

"Yields should peak out at 8 per cent and we may see some buying interest returning. State-owned banks may buy bonds as their deposits rise.''

Banks' deposits expanded 23 per cent in the 12 months through January 5, beating a 17 per cent increase in the previous year, central bank data showed.