Rupee down for second day on short-covering

An employee uses an electronic machine to check a rupee note inside a bank in Allahabad December 16, 2011.

MUMBAI (Reuters) - The rupee weakened for a second straight session on Wednesday as sustained dollar demand from oil firms and weak regional risk sentiment prompted investors to cover short dollar positions.

The rupee was also pressured after the Reserve Bank of India (RBI) Governor Duvvuri Subbarao was reported by media as saying inflation was "still quite high", denting hopes of a 50 basis point rate cut this month and sending shares and bond prices lower.

Traders expect the rupee to see some support in the near term as analysts still expect a 25 bps cut at the RBI policy review on January 29, which could sustain the strong foreign fund flows seen since last year.

Still, analysts warned strong gains were unlikely, with some even expecting falls, as the current account and fiscal deficits as well as high inflation continue to weigh.

"By March I expect USD/INR to test 56 and possibly breach that as the high CAD, high global crude and gold prices and ratings issues are all likely to contribute to a weak INR," said Rajeev Mahrotri, head of forex and debt trading at IndusInd Bank.

The partially convertible rupee closed at 54.69/70 per dollar versus its previous close of 54.6150/6250. It moved in a band of 54.68 to 54.8875 during the session.

Traders said oil firms, the biggest buyers in the domestic market, continued to buy the greenback to meet import commitments as global crude prices rose after robust U.S. retail sales figures.

A fall in shares after two days of gains also pressured the rupee as rate-sensitive stocks, such as ICICI Bank, retreated on Subbarao's comments. .BO

"I think equities are headed higher and we will see decent equity inflows but all this not enough to prevent higher USDINR in the short term. I would also rule out a sustained repo rate cutting cycle for now as inflation is still in the 7 percent handle," Mahrotri said.

In the onshore forwards, the 6-month forward premium rose to 186 points from 183 points at previous close while the 1-year climbed to 342 points from 333 points on Tuesday, as sentiment remained positive on the central bank's dollar credit facility for exporters.

In the offshore non-deliverable forwards, the one-month contract was at 55.02 while the three-month was at 55.59.

In the currency futures market, the most-traded near-month dollar/rupee contracts on the National Stock Exchange, the MCX-SX and the United Stock Exchange all closed at around 54.8450 with a total traded volume of $4.8 billion.

(Editing by Jijo Jacob)