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Credit Policy Surprises Bond Market

Reverse repo hiked by 25 basis points. Bank rate and CRR left untouched. Debt market react sharply, as 10-year benchmark yield shoots during early trades

The RBI Annual Policy Statement for the year 2005-06 has surprised the markets. The reverse repo rate has been hiked by 25 basis points to 5 per cent, as against the markets' expectations of a steady policy. However, the bank rate and the cash reserve ratio have been kept unchanged at 6 per cent and 5 per cent, respectively.

While the move is aimed at containing the inflation, some of the leading bond fund managers are of the view that the step would put an upward bias on the bond yields.

Binay Chandgothia, Deputy CIO and Head- Fixed Income, Principal PNB Mutual Fund, said, "Oil prices and how inflation moves from now onwards will shape the course of interest rates from here, though there will be a little upward bias in interest rates going forward and we can expect yields to go up by 15-20 basis points from here."

Prudential ICICI Mutual Fund CIO Nilesh Shah, though, sounded quite optimistic, as he explained, "It is a forward looking policy and the Central Bank has taken a step to proactively tame inflationary expectations. At the same time, it has proposed various steps to strengthen and deepen the Indian bond market. The repo rate hike will definitely have an impact on the interest rate and the market has already reacted as gilts trade 15-20 basis points higher after the announcement."

In the words of Suresh Soni, Head- Fixed Income, Deutsche Mutual Fund, "The Central Bank seems to be wanting to stay ahead of the market and the repo rate hike indicates that it is willing to be hawkish to control inflation. I expect the benchmark yield to stabilise at 7.25 per cent and stay range-bound thereafter."

In the meantime, the debt market has reacted sharply after the hike. The yield on the benchmark 7.38 per cent, 2015 GOI bond was quoting at 7.21 per cent during the morning trading session, up around 10 basis points compared to its previous close of 7.11 per cent.