By Swati Bhat
MUMBAI (Reuters) - Government bonds and stock markets rallied on Wednesday after the Reserve Bank of India (RBI) surprised investors by keeping rates on hold despite surging in retail and wholesale price inflation, but it kept the door open to more rate hikes saying further moves will be data-driven.
Financial markets had geared up for a quarter percentage point increase in key rates after record retail price inflation and a 14-month high reading on the wholesale price index. These prompted 39 of 43 respondents in a Reuters poll to predict a 25 bps hike.
The RBI unexpectedly kept the interest rates on hold, despite calling current inflation "too high". The central bank cited the prospect of easing retail prices and its concerns about the weak domestic economy.
The Sensex and the Nifty both extended gains to more than 1.4 percent after the policy review from being up 0.8 percent beforehand. The Sensex was trading up 1.2 percent while the Nifty gained 1.3 percent at 2.37 pm.
The partially convertible rupee closely mirrored moves in shares and was trading at 61.86 per dollar versus its previous close of 62.01/02.
The benchmark 10-year bond yield fell as much as 15 basis points on the day to 8.76 percent after the policy review.
"We see stability at the current level in bonds with buying appetite given lower supplies in coming months," said Shakti Satapathy, a fixed income strategist at AK Capital.
"The onus would now largely be towards the Fed announcement and the core CPI trajectory in the coming months. As both of the above triggers have been discounted in the market, we see a near-term chaos if the Fed announces something beyond expectations," he added.
Many analysts were surprised by the RBI rate-hold.
"It is completely unexpected given the liquidity in the system as well as the inflation trajectory," said Rupa Rege Nitsure, chief economist at Bank of Baroda in Mumbai.
"I think it is just postponement of action, because the policy clearly says they (the RBI) may take action any time, even in the interim between two policies, if the situation warrants," she added.
The U.S. Federal Reserve's two-day meeting ends late on Wednesday amid fears globally that the central bank will soon move to cut its monetary stimulus.
Worries about tapering have sparked foreign investor sell-off in Indian markets since they emerged in May, hitting bonds in particular.
(Editing by Subhadip Sircar and Richard Borsuk)
