Mumbai: Yields on the 10-year government bonds hit a three-year high on Wednesday after the Reserve Bank of India raised interest rates first time since 2014 but kept its neutral policy stance.

The 10-year bond yield closed at 7.917%—a level last seen on 15 May 2015, from its Tuesday’s close of 7.834%. Bond yields and prices move in opposite directions.

The repurchase rate was increased to 6.25% from 6%. The move predicted by four out of 15 economists in a Mint poll while rest expected unchanged.

Brokerage firm Nomura has termed the RBI policy as a “dovish hike". “The RBI’s decision to maintain a “neutral" stance suggests that it does not want to signal that it is embarking on a tightening cycle and that it remains data dependent", Nomura Holdings Inc. said in a report.

“We believe that both growth and inflation are likely to head higher in the coming months, paving the way for another 25bp rate hike in August. However, the ongoing tightening of financial conditions, higher oil prices and political uncertainty are likely to slow economic activity after September, in our view. Hence, we expect a pause thereafter. Global factors (oil prices, capital flows) are the main risks to this view", Nomura report added.

The central bank also increased its inflation forecast for the fiscal year 2018-19 to 4.8-4.9% for the first half and 4.7% in the second half of 2018-2019. In the previous policy review, RBI had predicted average inflation to be 4.7-5.1% for first half of the current fiscal and thereafter slow to 4.4% in the second half.

RBI policy statement flagged various factors—like volatility in crude oil, global financial markets, rise in domestic household inflation expectations, hardening of wages and input costs and the impact of implementation of house rental allowance by various state governments, that may push up inflation.

The bond prices were already under pressure due to external volatility such as rise in US bond yields, oil prices, geopolitical concerns and a trade war threat. Slowing inflows into local financial markets and the widening current account deficit have also dampened sentiment. So far 2018, foreign investors have pulled out around $4.5 billion from bond markets.

“We expect the RBI to hike by another 25 bps in the August policy but the call will hinge on how crude and INR movements pan out over the next few months, as well as, the extent of MSP hikes. We need to carefully look at the RBI minutes and observe the extent of upward pressure on food prices in the near term, risks of fiscal slippages, domestic growth recovery, and evolving global macro conditions (trade wars, DM monetary policy cycle, and commodity prices) to have greater clarity on the extent of RBI’s rate hike cycle", said Kotak Institutional Equities in a report.

Meanwhile, the rupee closed stronger against the US dollar. The currency closed at 66.92, up 0.34% from previous close of 67.15.

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