Gilt yields sprint as inflation crosses 5%

Bond prices at the longer end crashed by over Re 1 today, and the yield on the 10-year benchmark government securities touched 8.20 per cent intra-day on worries that the Reserve Bank of India (RBI) might raise interest rates in its quarterly monetary review next month, to contain the rising inflation rate.

The wholesale price-based inflation (WPI) rate closed at its one-year high of 5.24 per cent on June 10, sharply higher than 4.72 per cent a week earlier, factoring in the impact of the recent hike in oil prices.

The market was expecting the inflation rate to firm up around 5.10 per cent, absorbing the pass-through effect of the rise in domestic oil prices.

Senior bankers said the inflation rate might veer around this level till September on account of the base effect, but inch towards 6 per cent later this year. The RBI has projected an inflation rate of 5-5.5 per cent for 2006-07.

The economic and rates research report of JP Morgan Chase Bank, released in Singapore today, said the RBI could hike its key rate in July.

Rajeev Malik of JP Morgan Chase's Asia economic research wing did not rule out a hike in banks' cash reserve ratio (CRR) "later this year, if rate increases don't moderate the torrid pace of credit expansion, and excess liquidity remains a threat for higher inflation."

Nitin Jain, head-fixed income, ICICI Securities, a primary dealer, also said that with the rise in bond yield, expectation for a rate hike had become stronger.

The yield on the benchmark 10-year bond ended the day at 8.12 per cent. With this, the yield has climbed 43 basis points since the RBI raised its reverse repo rate by 25 basis points to 5.75 per cent on June 8.

The yield on the eight-year bond, which was auctioned yesterday, rose by about 25 basis points "" from 7.92 per cent to 8.13 per cent "" before settling down at 8.07 per cent. Similarly, the yield on the 15-year bond rose from 8.46 per cent yesterday to 8.64 per cent today, before settling at 8.60 per cent.

"The rise of yield was seen across the spectrum and we would not be surprised if the 10-year bond yield rose close to 9 per cent by the year end. The RBI seemed to have very little choice but to hike the rates," said a bond dealer.