The 10-year benchmark bond yield was steady at 8.34 percent, after trading in a 8.34-8.36 percent band.

Total volume on the central bank's electronic trading platform was 22.10 billion rupees ($462 million), compared with the normal 30-40 billion rupees dealt in the first two hours of trade.

"The policy expectation is for a 25 basis points hike, which is putting upward pressure on the yields," a trader with a private bank said. "Yields will touch 8.40 percent tomorrow."

Annual inflation in August was at 9.78 percent, the highest in more than a year as prices of food and manufactured goods surged, reinforcing the case for tightening policy despite weakening growth and a worsening global outlook.

Traders said cash outflows from the banking system due to tax payments by companies could also dampen demand for bonds.

The benchmark five-year overnight indexed swap rate was at 6.77 percent, up 3 basis points from its previous close, while the one-year rate was at 7.69 percent from 7.66 percent.

Global oil prices fell as rising fuel stocks and falling demand in top consumer the United States reinforced views that slowing economic growth and Europe's debt crisis will dent energy use, while a stronger dollar also kept prices under pressure.

Benchmark US 10-year notes yielded 1.9975 percent in Asian trade on Thursday, after rising 1 basis point to 2.01 percent on Wednesday.

Copyright Reuters, 2011