Bond yields have reached a 3-year high due to high inflation; will this cause the RBI to raise rates

After the consumer price inflation data revealed a sharper acceleration than economists had predicted, bond rates maintained their upward trajectory, surging further to reach close to a three-year high. In anticipation of the March Consumer Price Index (CPI) inflation data, which is predicted to remain over the 6-percent level, yields grew harder yesterday. Since the RBI reviewed its monetary policy, the yield on the 10-year bond has increased by 28 basis points in the last three trading sessions.

The 10-year bond yield increased 8 basis points at the beginning of the day to reach 7.278 percent. The 10-year bond yield was trading at 7.239 percent as of 11 a.m., up 5 basis points from its previous close of 7.19 percent and a level last seen on May 23, 2019. Bond yields and prices follow different trajectories.

The government's publication of retail inflation figures after market hours showed March inflation at 6.95%, a 17-month high. Food costs, which make up almost half of the CPI, increased by 7.68% in March compared to the previous month, or 5.85% on an annualized basis.

The primary metric used by the RBI to determine its policy is CPI inflation, which for the January–March quarter averaged over 6%. The mandated inflation objective for the central bank is 4%, with a +/- 2% tolerance on each side. If the RBI misses the mark three times in a row, lawmakers must take action.

According to economists, the six-member monetary policy committee (MPC) may start raising the repo rate from its June policy as a result of concerns about inflation.

The CPI inflation rate considerably exceeded the RBI's target range as a result of increased prices for energy, food, and logistics. According to Rahul Bajoria, managing director and chief India economist at Barclays, "We reduce our CPI projection to 5.8% for FY23 and now expect four 25-bp rate rises from the RBI in FY23, starting from the June MPC meeting. April CPI inflation is likely to be around 7.1%.

"Inflation for 2021–22 is already 5.5%, and the RBI expects it to increase to 5.7% for FY23," continued Bajoria.

UBS Securities, a brokerage, now anticipates a 50-75bps increase in the repo (policy) rate in FY23. As a result of increased borrowing demand, a rise in crude oil prices, and the RBI's decision to implement the standing deposit facility, which will now serve as the floor of the interest rate corridor, at a rate of 3.75 percent, the bond yield is already under pressure. The RBI has indirectly tightened the market by 40 basis points by essentially eliminating the reverse repo, which is currently at 3.35 percent.

In its bimonthly policy, the RBI also increased its annual inflation forecast from 4.5 to 5.7% while decreasing its growth forecast for FY23 from 7.8% to 7.2%.

"Worldwide energy and commodity prices have increased significantly as a result of the Russia-Ukraine conflict. A possible cause of fresh supply chain disruption is China's tightening of COVID-19-related regulations. Additionally, Tanvee Gupta Jain, Chief India Economist at UBS Securities, noted that the full effect of increased global crude oil prices being passed on to local retail pricing of gasoline and diesel has not yet been shown in headline inflation data and will be seen in April.

Bond yields are anticipated to increase following an inflation rate that is likely to have reached 7.5% in the first half of the current fiscal year.

"We anticipate that the 10-year government securities (G-Sec) yield will soon cross 7.2% due to the sharp increase in CPI inflation in March 2022. The 10-year G-Sec yield could test 7.5% in the first half of FY23, according to Aditi Nayar, chief economist at ICRA, as expectations for early bond index participation wane.]

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