The 10-year bond yield ended at 8.10%, unchanged from Thursdays close, but off an intraday peak of 8.12%, its highest since April 29. Government data showed Indias wholesale price index rose 8.1% in the 12 months to May 17, the highest since September, 2004 and up from the previous weeks 7.82% rise.
Chances of a rate hike appear very strong, but there is uncertainty about the timing, a trader with a foreign bank said.
Advance tax outflows, which are expected mid-June, will suck out about Rs 20,000-25,000 crore from the banking system which auctions of Rs 10,000 crore under the regular auction between May 30-June 6 and another Rs 6,000 crore expected during the third week of June will make things worse.
Instead, the central bank has been tightening cash conditions over the past 18 months, most recently in April and May, when it raised the cash reserve ratio, the amount of funds banks must keep with it, by 75 basis points to a seven-year high of 8.25%.
Indias economy grew 8.8% in the March quarter from a year earlier, higher than the median forecast of 8.2%.
Call rates ended at 7.00/7.25%, lower than its previous close of 7.80/8%.
The Reserve Bank of India sold Rs 10,000 crore worth bonds on Friday, the cash settlements for which took place on Monday.
The weighted average rate in the call money market was 7.97%, while collateralised borrowing and lending obligation (CBLO), a secured form of money market lending, was 7.58%, according to the Clearing Corp of India (CCIL).
Volume in the call money market was Rs 11,392 crore and in CBLO it was Rs 51,616 crore, CCIL data showed.
The central bank absorbed a marginal Rs 30 crore through its daily reverse repo auction on Friday, while it pumped in Rs 9,630 crore through the repo auction, indicating a severe cash squeeze in the banking system.
Meanwhile, rupee climbed to its highest in more than two weeks on Friday, after the government relaxed overseas borrowing rules for local firms and raised foreign investment limits in domestic bonds.
The partially convertible rupee ended at 42.45/46 per dollar, off an intraday peak of 42.43, its highest since May 15. The mood on the rupee is changing after the external commercial borrowing news and there seems to be a tendency for exporters to come and sell dollars, said Madhusudan Somani, associate director (financial markets) at Yes Bank. There is a fairly decent two-way interest, there is demand from oil refiners and new exporters are also coming and selling in the markets, he said.