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 MUMBAI: Indian federal bond yields edged down on Tuesday as investors covered short positions after a deputy central banker said the bank's October policy guidance still holds, leading traders to believe there will not be more interest rate increases in the near term.

After market hours on Monday, Subir Gokarn, a deputy governor of the Reserve Bank of India, also said any decision to opt for open market operations will be dictated by liquidity conditions and not by government bond yields.

At 11:15 a.m. (0545 GMT), the new 10-year bond yield was at 8.93 percent, 3 basis points (bps) lower than its Monday's close.

Total volumes on the central bank's electronic trading platform were high at 59.5 billion rupees ($1.2 billion) compared to the normal 35 billion to 45 billion rupees dealt in the first two hours of trade on average.

"Short-covering has been triggered by Gokarn's comments yesterday but there is no clarity yet on the open market operations front," the head of trading at a foreign bank said.

"I expect the 10-year bond to hold in a 8.90 to 8.96 percent band today."

Some traders see Gokarn's comments as a sign the RBI may opt for OMO to boost liquidity, a move that could ease bond yields.

However, some others believe the central bank will move to OMO only if the liquidity crunch seems long-drawn, and currently the overnight money rate seems stable, preventing a further fall in yields.

"We will have to wait and watch if they do announce OMOs as that is the only solution to helping ease the current tight liquidity which will in turn ease supply pressures," a senior dealer with a private bank said.

Banks borrowed 916.35 billion rupees from the central bank's repo counter under the liquidity adjustment facility on Monday, below 1.27 trillion rupees borrowed on Friday but well above the central bank's comfort zone of plus or minus 1 percent of banks' total deposits.

Traders, however, said Gokarn's comments were helping sentiment, especially after data on Monday showed inflation stayed high in October.

After raising rates in October for the 13th time since early 2010, the RBI had indicated it could pause in December if inflationary pressures start to ease.

India's wholesale prices rose more than expected in October as the cost of food and fuel increased, raising doubts about the central bank's outlook that price pressures will abate by the end of the year.

The 130-billion-rupee bond auction announced for Friday is expected to prevent a sharp fall in yields, traders said.

The benchmark five-year swap was down 6 bps at 7.32 percent, while the one-year rate was 3 bps lower at 8.1 1 percent.

"Tight liquidty is not letting the 1-year rate fall as much as the 5-year," the chief fixed income trader at a state-run bank said.

Copyright Reuters, 2011