Inflation blues hit bonds

MARKET ROUND-UP

Bonds fell, pushing the benchmark 10-year yields to the highest in more than five months, after Reserve Bank of India Deputy Governor Rakesh Mohan said inflation was a key concern and policy makers would "respond swiftly'' to curb a rise in prices.

Mohan said in a speech in Mumbai the climb in global short-term interest rates was not reflected at the long end of the yield curve, which spurred more losses in bonds.

The curve, which represented the yields of different maturity bonds, was used to evaluate the future of interest rates. The Reserve Bank of India would use all policy tools to combat inflation, Mohan said. "All of this is pointing toward higher interest rates,'' said R A Sankaranarayanan, chief of trading at state-owned Bank of India in Mumbai.

"There are better chances of an increase in the cash reserve ratio. We've already seen the yields moving up on those comments on the long-end of the curve.''

The yield on the benchmark 8.07 per cent bond due January 2017 rose 13 basis points, or 0.13 percentage, to 7.96 per cent as of the 5:30 pm close in Mumbai. That is the highest since August 30.

The price of the security fell 0.85, or 85 paise, to Rs 100.75, according to the central bank's trading system. The fall today is the biggest since January 12.

The central bank, which raised the overnight lending rate for the fifth time in a year on January 31, is fighting to prevent inflation from derailing economic growth that reached an unprecedented 9 per cent in the year ended March 31, 2006.

"The firming up of inflation bothers us,'' Mohan said."It does represent a key concern for us in overall macroeconomic management.''

The Reserve Bank in December also decided to raise the amount of cash lenders must set aside to cover deposits, or cash reserve ratio, by half a percentage, to remove excess cash from the banking system.

Inflation accelerated to 6.58 per cent in the week ended January 27, the fastest pace in more than two years, the government said on February 9. That was more than a percentage higher than the upper end of the 5 per cent to 5.5 per cent range targeted by the central bank for the financial year through March.

``Changes in the short-term rates have not transmitted to the longer end of the yield curve,'' Mohan said. "There's a great compression of spreads and the yield curve has flattened.''

Bonds may pare losses on speculation an increase in cash surpluses with banks will encourage them to buy debt.

"There is speculation the central bank sold the rupee in the currency market which boosted the cash surplus in the system,'' said Rajesh Babu, a trader at state-owned Andhra Bank in Mumbai. "That may help bonds recover losses.''

The central bank net drained funds from the banking system for four days through today. Before that the bank had been adding funds to the system since December 13.