Indian bonds close lower on expectations for higher retail inflation

The Indian government bonds closed lower on Monday as investors expect higher retail inflation in May, which has raised concerns that the Reserve Bank of India (RBI) may not be able to slash rates at the up-coming policy meeting.

The yield on the benchmark 10-year bonds, which moves inversely to its price rose more than ½ basis point to 7.498 percent, yield on super-long 30-year bonds also jumped more than 1/2 basis point to 7.855 percent and the yield on short-term 2-year note climbed 1-½ basis point to 7.102 percent by 12:30 IST.

The CPI for May is due on Monday (17:30 IST). The April release showed CPI inflation rising more than expected, to 5.5 percent y/y, forcing the RBI to adopt a hawkish tone at last week’s monetary policy meeting. We continue to see upside risks to the RBI’s inflation forecast of around 5 percent in FY17 and think that sticky service sector inflation will remain the main obstacle to the central bank easing further. We think that CPI inflation will edge up to 5.5 percent y/y in May while the consensus is for 5.6 percent y/y.

According to our poll of 10 economists, CPI inflation is expected at reach 5.5 percent in May, compared to the 5.39 percent in April.

In the recent bi-monthly monetary policy meeting, Reserve Bank of India Governor Raghuram Rajan made it clear that the target is to achieve five percent inflation by March 2017, while giving hints of further easing in the futures, besides concerns over upward pressure on food and commodity prices.

Retail inflation has almost more than halved since Nov 2013 but spike in petrol and diesel prices by more than five percent since May 1 has led to market hopes of a rise in May inflation. Items such as sugar and milk in the consumer sector are likely to shoot up prices.

Meanwhile, the Sensex closed down 0.90 percent or 238.98 points to 26,396.77 and Nifty-50 futures down 0.85 percent or 69.40 points at 8,126.50.