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Inflation Breaches 6 per cent Mark

There was little hope in the market through the week as concerns of high inflation, tightening liquidity and speculation over upward revision of interest rates governed market sentiment

The biggest damper for the bond markets was inflation touching two-year high levels at 6.12 per cent for the week ending January 6, 2007.

Bond markets started on a positive note as bonds tried to recover some of the previous week's losses. By January 16, the yield on the benchmark 7.59 per cent GOI 2016 bond had dropped by 14 basis points to 7.76 per cent. But subsequently, comments by a finance ministry official on January 17 hinting at the implementation of the amended Banking Regulation Act as early as January 31, 2007 triggered a sell off by investors.

The amendment would give central bank the autonomy to lower the Statutory Liquidity Ratio (SLR), which is the mandatory level of deposits that banks are required to hold in bonds. Such a move is likely to hit the trading volumes in the market. The demand from banks has often provided support to the market during bear phases. Traders hence fear the loss of such a cushion. As a result, the markets pared much of the gains made earlier during the week and the yield on the benchmark 7.59 per cent GOI 2016 bond closed at 7.78 per cent on January 17 after touching an intra day high of 7.85 per cent. The yield finally settled at 7.8 per cent at the end of the week on January 19.

Speculation was also rife with respect to the impending GOI auction of 15-20 year security for Rs.5,000 crore, scheduled between January 18 - 25, 2007. Given that there is not much demand for such paper, the central bank revised the security auction to a security with 14 year tenure. This announcement came after trading hours on Friday, January 19.

However the market could have been worse but for the declining oil prices which restricted the fall to some extent. Call rates looked to be on a recovery path as they ended the week at 7.70-7.90 per cent, lower than previous week's 8-8.20 per cent.

Outlook
It is unlikely that traders will be very active during the initial part of the next week. Data released on Friday, January 19 revealed that the CRR hike which was targeted at curtailing inflation has failed to check increase in money supply. These developments are likely to rationalise a further increase in interest rates in the January 31 policy review.

Traders are unlikely to take large positions in the market and yields are likely to remain range bound.