Mumbai: Federal bond yields rose on Thursday as fears of stringent monetary tightening by the central bank heightened after food inflation surged to its highest level in more than a year.
Food price index rose 18.32% and the fuel price index climbed 11.63% in the year to 25 December, government data on Thursday showed. In the prior week, annual food and fuel inflation stood at 14.44% and 11.63%, respectively.
“This number reinforces the base case scenario of a 50 basis point rate hike in January. One has to be prepared now for a much larger frontloaded rate hike series than what one was expecting say a month ago,” said Hitendra Dave, head of global markets at HSBC India.
The most-traded 8.08%, 2022 bond ended at 8.16%, up 6 basis points (bps) from previous close, while the illiquid benchmark 10-year bond yield ended 7 bps higher at 8.13%.
The second-most actively traded 8.13%, 2022 bond ended at 8.13%, up 6 basis points from previous close. However, many market participants still believe the Reserve Bank of India (RBI) will prefer a “baby step” approach on rates.
The central bank is expected to raise interest rates by at least 25 basis points on 25 January when it reviews policy, a Reuters poll showed on Wednesday. Most analysts forecast rates to rise by at least 75 bps in 2011.
“RBI will have to be careful with rates as we are now in territory where aggressive rate hikes could feed inflation instead of lowering it because liquidity in the banking system is already scarce,” said a dealer with a state-owned bank.
Dealers said the liquidity deficit in the system is around Rs 75,000-80,000 crore against RBI’s “comfort” level of a deficit of around Rs 50,000 crore.