Bonds rallied to a four-month high on Wednesday after the Reserve Bank of India sharply reduced inflation projections for the current fiscal, raising hopes of a rate cut .
Bonds rallied to a four-month high on Wednesday after the Reserve Bank of India sharply reduced inflation projections for the current fiscal, raising hopes of a rate cut .The 10-year 6.79%, 2027 benchmark bond yield closed at 6.57%, 7 basis points lower than Tuesday’s close, and the lowest since February 7. The 7-basis-point fall is the biggest intra-day drop since May 16, when it fell 14 basis points. “Nobody is talking of a rate hike anymore and that caused today’s relief rally. As we move towards the inflation data in July and the next policy in August, the bond yields would point towards a rate cut,” said Jayesh Mehta, MD, Bank of America Merrill Lynch. Traders said the immediate upside available to the bonds is limited since they they have already rallied significantly in the last few weeks, adding that the benchmark yield could fall another 5-7 basis points over the next week. The benchmark yield has fallen 42 basis points since the beginning of May. The market will keenly watch the next two inflation prints, expected in mid-June and mid-July, since the RBI’s next action will depend on this data to a large extent. While the market is hopeful that inflation will move south in coming months, it is important that the RBI’s inflation modelling follows the same trajectory, traders said. In April, the consumer price inflation dropped to a record low of 2.99% from a nearly five-month high of 3.89% in March because of a lower base effect and lower food prices.
In its policy statement, the RBI highlighted risks to inflation and said premature action at this stage risks disruptive policy reversals later and the loss of credibility. Accordingly, the MPC decided to keep the policy rate unchanged with a neutral stance and remain watchful of incoming data, it added. However, the central bank cut its inflation projection to a range of 2-3.5% in the first half of the fiscal, from its earlier projection of an average of 4.5%. For the second half of the fiscal, the RBI expects inflation to be in a range of 3.5-4.5%, lower than its previous projection of an average of 5%.
Given that the RBI has cut its inflation projection, a section of the markets believes that there is a significant possibility of a rate cut in August. “The RBI has changed their trajectory. It seems like the RBI is trying to buy time to cut rates. If the next two numbers are lower, we will definitely see a rate cut,” said Naveen Singh, senior VP at ICICI Securities Primary Dealership.
Kotak Economic Research, however, said a case for a rate cut will be strengthened only with a downside surprise to RBI’s inflation estimates for the second half of the current fiscal. The RBI also cut the SLR, the proportion of deposits banks have to maintain in liquid assets such as government bonds, gold, cash, etc, to 20% of their net demand and time liabilities (NDTL) from 20.5%. However, it kept the ceiling on amount of SLR securities that can be held under the ‘held to maturity’ category unchanged. This move is unlikely to have an immediate impact since banks hold much more than the stipulated amount in SLR due to poor loan demand. Moreover, the dovish tone of the RBI makes a case for more bond purchases by the banks, traders said.