Inflation up but holding below 12 pct

By Surojit Gupta and Rajkumar Ray

NEW DELHI (Reuters) - Indian inflation rose to 11.91 percent in early July, below forecasts and only slightly higher than the previous week, sending bond yields down on reduced risk of monetary tightening before a Reserve Bank of India policy review.

The rise in the wholesale price index for the 12 months to July 5 fell short of expectations for an annual increase of 12.05 percent but just topped the previous week's 11.89 percent to be the highest since the index became available in 1995.

The RBI increased its key lending rate, the repo rate, by 75 basis points to 8.5 percent in June, its highest in six years, to combat a surge in inflation.

Its next review is on July 29 and economists said even though momentum in inflation appeared to have moderated, this did not indicate prices would start to ease, adding pressures in the manufacturing economy continued.

"The risk of second-round effects of inflation has risen and we expect the RBI to hike the repo rate by 25 basis points on July 29," said Sonal Varma, an economist at Lehman Brothers.

"But we do not rule out a more aggressive 50-basis-point hike later this month."

Before the data, Finance Minister Palaniappan Chidambaram said recent steps by the central bank had started working and he did not rule out more measures by the government to tame prices.

"There is still pressure on prices. There are signs that monetary steps are taking effect. M3 (money supply growth) is slowing down," Chidambaram said.