By Archana Narayanan
MUMBAI (Reuters) - Bonds ended slightly higher on Wednesday, giving up most of their intraday gains that saw the 10-year yields drop to their lowest since December 2009, as profit-taking offset growing expectations for a rate cut.
Bond yields slumped earlier in the day after Reserve Bank of India Governor Duvvuri Subbarao said he had taken note of falling inflation, which investors interpreted as a signal of a potential shift in the central bank's hawkish stance.
The comments came after data on Tuesday showed headline wholesale inflation fell below 5 percent in April, raising expectations the RBI could cut interest rates again at its next policy review on June 17. It has cut policy rates by 75 basis points so far this year.
Bond yields have dropped close to 40 basis points since the May 3 policy due to hopes of easing inflation, expectations for continued bond purchases from the RBI and a global market rally.
Still, some analysts were cautious about whether bond prices would gain further, while expressing doubts about how aggressively the RBI would actually end up cutting rates given continued concerns about the wide current account deficit.
"We are sceptical on whether the rally has legs, especially in light of the RBI commentary at the recent review and the 70 percent jump in trade deficit," said Radhika Rao, an economist with DBS Bank in Singapore.
The 10-year bond yield fell 1 bp to 7.46 percent, after earlier falling as low as 7.35 percent, the lowest since December 2 2009.
The benchmark 5-year swap rate ended 3 bps up at 6.75 percent, after earlier hitting its lowest since September 2011. The one-year rate rose 1 bp to 7.10 percent, after hitting 7.07 pct in the day, the lowest since early January 2011.
The bonds rally has prompted economists and investment banks to revise rate cut expectations.
Bank of America-Merrill Lynch expects the central bank to cut interest rates by 25 basis points on June 17, with another 25 bps in July - revising its prior expectation of a cut in October - according to a note on Wednesday.
The rally has been supported by foreign investors, who have bought $1.51 billion of debt so far in May, more than $992.2 million for the whole of April, regulatory data shows.
Bonds have also been bolstered by hopes the RBI would buy bonds. Tight liquidity conditions have led lenders to borrow over 1 trillion rupees from the central bank's repo window in six of the last seven sessions.
The rally in benchmark bonds has come even as India is set to introduce a new 10-year paper on Friday with an auction of 70 billion rupees. It closed below the repo rate at 7.22 percent, from its last close of 7.32 percent in the when-issued trades.
India is set to start the long-awaited sale of inflation-linked government bonds next month, while Larsen & Toubro Ltd became the first domestic company to issue such debt.
(Editing by Prateek Chatterjee)
