Mumbai: Government bonds yields hit over a 14-week high Wednesday as rising retail inflation doused hopes of a cut in interest rates by the Reserve Bank of India (RBI) in its upcoming policy.
The RBI’s monetary policy committee (MPC) is scheduled to meet on 4 October.
Yields, which are inversely related to the prices of government securities, ended Wednesday at 6.584%, a level last seen on 6 June. They had closed at 6.554% the previous day.
According to official figures released on Tuesday, consumer price index-based inflation—the gauge used by the MPC to decide on monetary policy—continued to rise for the second consecutive month in August, as food inflation turned positive after three months of contraction.
Inflation rose to 3.36% in August compared to 2.36% a month ago.
“A higher core (inflation reading), and August headline inflation on the higher end of the central bank’s 2-3.5% target for (the first half of fiscal 2018) will douse any lingering expectations for an October rate cut,” Radhika Rao, India economist at DBS Bank wrote in a note on Tuesday.
Core inflation, which excludes volatile components of food and fuel, stood at 4.47% in August compared to 3.93% in July.
According to Soumyajit Niyogi, associate director at India Ratings, benign inflation prints in the past few months have supported prices of government bonds.
With expectations of higher inflation going ahead as the favourable base effect reverses and also a little push from expected housing rent allowance increase by state governments, yields are expected to trade with an upwards bias in the near-term, he said.
Bond dealers said the rise in yields will depend on the liquidity operations of the central bank. The RBI has been selling bonds through the so-called open market operations (OMOs) in order to suck out systemic liquidity, which has been in surplus since demonetisation.
The RBI has sold bonds worth Rs40,000 crore via OMOs so far this fiscal and is scheduled to hold another such auction worth Rs10,000 crore.
Expectation of further OMO announcements, as liquidity remains in surplus of around Rs3 trillion, is also expected to keep yields elevated as it would increase the supply of securities, in addition to the regular weekly supply under the government’s borrowing programme.
Higher yields on government bonds will also impact corporate as the borrowing costs would rise. Corporate bonds are priced at a spread over the yield of government debt.
On Wednesday, secondary market yield on 10-year AAA-rated bonds of Rural Electrification Corporation, which are seen as a proxy for sovereign, is quoted at around 7.42%.
While top rated borrowers, those in the AAA and AA+ segment, may still attract investors at current prices, those below the rating curve may have to shell out extra, according to bond dealers.