Bonds crack as surge in inflation leads to speculation of June rate hike by RBI

Yield on the 10-year benchmark 6.54 per cent 2032 paper shot up as much as 9 basis points to 7.28 per cent. Bond prices fall when yields rise.

Data released after trading hours on Tuesday showed that India’s Consumer Price Index based inflation had surged to a 17-month high of 6.95 per cent in March from 6.07 per cent a month ago.

The March inflation print is well above the upper bound of the RBI’s comfort zone of 2-6 per cent for the price gauge. The central bank aims to keep CPI inflation at 4 per cent over the medium term.

Market participants had expected the inflation reading at around 6.40 per cent. The sharp increase in inflation in March was largely driven by hardening food prices.

With India facing strong inflationary pressures from the surge in global commodity prices following Russia’s invasion of Ukraine in February, pressure is mounting on the RBI to act swiftly to anchor consumer prices.

While the RBI set the stage for withdrawal of accommodation at its policy statement last week and effectively raised the operative cost of funds by shrinking the interest rate corridor, bond traders now expect the central bank to hike the repo rate in June.

“With the inflation outturn materially to the upside and momentum still rising, we are lifting our terminal repo rate forecast to 6% by Q3 2023 with a 25bp rate hike at each of the next eight MPC meetings,” economists from Nomura wrote.

“We see elevated risk that rate hikes could be even more frontloaded, with a 50bp hike in one of the meetings in 2022, given that monetary policy often works with long lags.”

The likely rise in benchmark interest rates and sovereign bond yields is seen increasing borrowing costs throughout the economy. Government bond yields are the benchmarks for pricing a vast variety of credit products.