MUMBAI (Reuters) - Government bonds rallied on Tuesday after the central bank toned down its rhetoric on inflation and hinted it would not raise interest rates further as long as inflationary pressures continued to ease.
The more dovish tone offset the initial negative impact from a cut in the banks' statutory liquidity ratio, or the amount of bonds lenders must park with the Reserve Bank of India, by 50 basis points to 22.50 percent.
The cut in the SLR and the new tone were seen by markets as moves that would be welcomed by the new pro-business government as it seeks to revive economic growth, with the RBI also keeping interest rates on hold as widely expected.
The benchmark 10-year bond yield was at 8.62 percent at 12:12 p.m., down 11 basis points from the day's high when markets had a knee-jerk reaction to the SLR cut. The yield had closed at 8.66 percent on Monday.
"The cut in SLR won't matter in the short term as much. We have held the view that under (RBI Governor) Rajan's tenure we should see SLR going towards the 20 percent mark," said Arvind Chari, head of fixed income and alternatives at Quantum Advisors.
"We are pleasantly surprised with RBI's stance on policy easing if inflation falls faster than anticipated. I think market should take it as a very strong message and hence unless there are some external oil price or food shocks, we should see bond yields headed lower," he added.
Some dealers also said the possibility of a rate cut in the second half of the year has risen following the latest statement with the government likely to play an active role in containing supply-side inflation.
Rate-cut expectations were also reflected in the overnight indexed swaps with the benchmark five-year swap rate falling 10 basis points to 7.99 percent and the one-year rate dropping 12 basis points to 8.28 percent, from pre-policy levels.
The two rates had closed at 8.08 percent and 8.39 percent, respectively on Monday.
Editing by Subhranshu Sahu