MUMBAI (Reuters) - Gains in Indian markets after the RBI surprised with a higher than expected cut in interest rates are unlikely to be sustained after the central bank also warned inflationary risks would limit the scope of further easing.
Though markets initially rallied after the announcement — after the RBI delivered a 50 basis points cut — traders were also caught unawares by the RBI’s renewed warnings on inflation, as well as its move to keep the cash reserve ratio on hold inspite of tight cash conditions.
“When you look at it objectively, 25 basis points would have been a token. I think rate cut expectation will remain very, very contained and a lot will depend on growth and inflation numbers,” said Nirav Dalal, president of debt capital markets at Yes Bank.
“Based on the current and evolving environment, to expect significant rate cuts in the remaining year might not be possible.”
(Read main story, RBI cuts repo rate, click here)
(Also read, Expert views on RBI's move to slash repo rate, click here)
(Highlights of RBI's rate move, click here
Federal bond yields fell to their lowest in over a month.
The 10-year bond yield was trading down seven basis points at 8.38 percent from Monday’s close, though it had earlier fallen to as low as 8.22 percent immediately after the rate decision.
The reduced expectations for rate cuts could put a floor on yields, especially given the hefty bond sales expected on the back of the government’s higher-than-expected borrowing plans of 5.7 trillion rupees for the fiscal 2012/13 year.
In rates markets, the 1-year swap rate lost 11 basis points to 7.86 percent, while the 5-year rate fell 7 basis points to 7.45 percent after the rate decision. The near-end had closed at 7.92 percent, while the 5-year had ended at 7.48 percent on Monday.
The rupee, was trading at 51.58/59, after earlier hitting a session high of 51.50, compared with Monday’s close of 51.68.
“The comment that further room to cut rates is limited may limit INR gains,” said Jonathan Cavenagh, an FX strategist for Westpac in Singapore.
“We still have (the) policy rate down at 7.5 percent by the end of this year but further cuts may not happen in Q2,” he added.
Analysts said that inflation would be a key factor that would determine further policy easing. Data on Monday showed a marginal easing of the headline wholesale price inflation, though manufacturing inflation fell more sharply.
How the RBI deals with liquidity will also be key, according to traders.
Liquidity in the banking sector has eased, but it remains acute, with some analysts questioning the extend to which lenders can pass on lower borrowing costs unless the RBI injects liquidity more directly via a cut in the cash reserve ratio.
“Now, we will have to see if the banks will pass on this cut as aggressively to industry,” said Jagannadham Thunuguntla, head of research for SMC Global Securities.
India’s bank sub-index was last up 0.4 percent, after earlier gaining as much as 1.7 percent. The paring of gains brought back broader stock indexes, with the Nifty and Sensex up 0.5 percent each.
Reporting By Archana Narayanan, Abhishek Vishnoi, Manoj Dharra, and Aditya Phatak.; Editing by Subhadip Sircar