Indian bond yields drop as central bank OMO seen this week

MUMBAI: Indian government bond yields ended lower on Monday, retreating from the day's highs, as hopes the central bank will announce a second consecutive week of debt purchases offset a new warning on inflation from the RBI governor.

Despite continued doubts about the scope of interest rate cuts, investors are betting Indian bonds are set for their biggest rally since the global financial crisis, wagering that the government will unveil a fiscally disciplined budget on Feb. 28.

Bonds could also remain supported ahead of the 2013/14 budget, given the government only has one more weekly sale of debt left for the year ending in March, while the central bank could conduct open market operations (OMOs) to ease liquidity deficit.

"System is liquidity strapped, but the market may take a breather from the fact that this week would be the last scheduled auction and take the fresh cues from the budget," said Rudraksh Bhatt, senior associate vice president at Darashaw and Company.

The benchmark 10-year bond yield closed down 1 basis point (bp) at 7.82 percent, after rising to the day's high of 7.85 percent.

Total volumes on the central bank's electronic trading platform stood at a low 210.5 billion rupees ($3.9 billion) compared to the average 300-350 billion rupees in recent weeks.

Domestic bond markets will be closed on Tuesday for a banking holiday.

Yields had initially risen after Reserve Bank of India Governor Duvvuri Subbarao on Saturday reiterated the central bank had "limited" scope for further monetary easing and said inflation continued to face upside risks.

However, yields retreated from the session's highs on hopes the central bank will announce bond purchases for the week as early as later on Monday given the cash deficit in the banking system has stayed above 1 trillion rupees for eight consecutive sessions.

The benchmark 5-year OIS rate closed up 2 bps at 7.26 percent while the 1-year rate closed up 3 bps at 7.63 percent.

Traders expect the OIS rates to edge down by 2-3 bps this week with the fall in the short-end likely to be bigger if the central bank announces an OMO later on Monday.?Reuters