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Rate Hike Surprises Bond Traders

Over the week, yield on the benchmark 7.38 per cent GOI 2015 bond dipped a massive 17 basis points to end at 7.27 per cent as against its previous week's close of 7.10 per cent

The week ended January 27, 2006, proved to be a tough one for the bond markets. The rate hike in the quarterly credit policy review caught the market participants by surprise. The bonds suffered heavy losses as the yields surged. The yield on the benchmark 7.38 per cent GOI 2015 bond ended at 7.27 per cent, up a massive 17 basis points from its previous week's close of 7.10 per cent.

The RBI announced its third quarterly credit policy review on January 24, 2006. The reverse repo and the repo rates were hiked by 25 basis points to 5.5 per cent and 6.5 per cent, respectively. The bank rate and the cash reserve ratio (CRR) were kept unchanged at 6 per cent and 5 per cent, respectively. The RBI also raised the forecasted economic growth rate for the current fiscal from 7-7.5 per cent to 7.5-8 per cent. The move is largely seen as a measure to put a tab on the inflationary pressures in the wake of higher oil prices and booming Indian economy. However, it triggered a slide in the bond markets as the announcements were against the expectations of the traders who were predicting that the central bank might keep the rates unchanged.

It was a curtailed trading week because of a holiday on account of Republic Day. Bond markets lost ground right from the start of the week. A surge in the crude oil prices turned the sentiments negative on Monday. Markets also showed nervousness ahead of the credit policy review. And after the review, bond prices kept heading southwards as they adjusted to the rate hike.

The inflation rose to 4.4 per cent for the 12-month period ending January 14, 2006, as against previous week's 4.24 per cent. The rise came on the back of costlier manufactured products, even though the food items registered a decline in the prices.

The Indian rupee weakened earlier in the week owing to higher dollar demand from the oil companies. Higher oil prices weighed upon the greenback, prompting the oil companies to step up their dollar purchases. But subsequently, euro's gains against the dollar, coupled with strong fund flows into the economy supported the rupee well as it ended the week stronger at 44.15 per US dollar. Call rates rose sharply during the week to end at 7.60-7.80 per cent, as against previous close of 6.40-6.60 per cent.

Outlook
After struggling in the just concluded week, bond markets are expected to start off on a cautious note in the next week, and there might be more downside to the bonds. Apart from that, market participants will look forward to the forthcoming FOMC meet and the twin gilt auction worth Rs 9,000 crore scheduled to be held in the first week of February.