Stiff bond yield curve signals hardening interest rate

10-year gilt yield crosses 8% after four years; bond market jittery about rate hike by RBI.

The yield on the benchmark 10-year government bond today pierced the psychologically important 8 per cent level as nervousness gripped the bond market over a possible interest rate hike by the Reserve Bank of India (RBI). This is a four-year high for the benchmark bond's yield.

With this, the entire yield curve has stiffened, making the gap between the cost of overnight money and 10-year money stand at 225 basis points. One basis point is one-hundredth of a percentage point.

Today, the cost of overnight money is 5.75 per cent; of one-year 7 per cent; five-year 7.60 per cent; and 10-year 8 per cent. "The stiff yield curve indicates that the inflationary expectations are high and the rates can go up further," said a bond dealer.

The latest inflation data, to be released tomorrow, is expected to show wholesale price-based inflation at above 5 per cent, as the impact of the oil price hike will be factored in.

The RBI, at its Rs 4,000 crore 15-year bond auction today, set the cut-off yield at 8.46 per cent. The cut-off yield for the eight-year Rs 5,000 crore paper was set at 7.92 per cent. A month back, the 15-year paper's yield was 7.94 per cent, and that of the eight-year paper was 7.37 per cent.

"There has been a dramatic change in the sentiment of the bond market after the RBI raised the auction amount from Rs 5,000 crore to Rs 9,000 crore. The yield on the 10-year benchmark paper has risen by 20 basis points over the last few days and it can go up further," said a senior banker.

Sanjeet Singh of I-Sec, a primary dealer, also echoed the same sentiment when he said, "The Reserve Bank is behind the curve and the market has been ahead of the central bank. However, even the market could be behind the curve in pricing the potential interest rate."

Bond dealers expect the 10-year yield to touch 8.25 per cent soon, even if the RBI refrains from any rate hike in its quarterly review of policy next month.

The 10-year yield, which was veering around 7.67 per cent on June 8 when the RBI hiked its reverse repo rate to 5.75 per cent, had shot up to 7.80 per cent immediately.

The next 20 basis points' rise has been triggered by the RBI's decision to hike the quantum of bond auction to soak excess liquidity from the system. With today's auctions, the government has raised Rs 52,000 crore from the market through dated securities, out of the Rs 1,52,500 crore yearly borrowing programme.

"The government's cost of borrowing will go up. Even the corporates will have to pay more for their loans as banks' cost of funds is going up," said the chairman of a public sector bank.