India's bond market signals extended rate pause despite low inflation
retail inflation
gauge falling to an eight-year low of 1.55%, way below Mint Road's ordinary legal mandate of 4%. A spike in yields has widened the spread between 10-year bonds and the repo rate to almost one percentage point-the most in 2025. "The widening of the spread between the 10-year yield and repo rate is an indication that the market is pricing in an extended policy pause," said Churchil Bhatt, executive vice-president, investment, Kotak Mahindra Life Insurance. "After the last
monetary policy
, market participants believe that the bar for further rate cuts is fairly high. Traders have given up hopes of an October rate cut."
The spread widened to 99 basis points on Tuesday, compared with around 20 bps just before the
Reserve Bank of India
(RBI) started the rate-cutting cycle in February under its new governor Sanjay Malhotra. One basis point is a hundredth of a percentage point.
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Bond traders now expect 5.5% as the terminal repo rate, against 5% expected before last week's policy. The central bank has eased rates by a cumulative one percentage point this year.
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RBI allows non-residents to invest rupee surplus in vostro accounts in G-secs
The Reserve Bank of India (RBI) on Tuesday said non-residents maintaining special rupee vostro accounts (SRVA) can invest surplus balances in central government securities (G-secs).
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Inflation as measured by the
consumer price index
(CPI) fell to 1.55% in July, below the lower bound of the central bank's target range of 2-6% with 4% as the mid-point. Economists had anticipated a CPI reading of below 2%.
However, despite the low CPI print, the bond markets are not pricing in a rate cut in October because the central bank's projections show inflation would climb toward the end of FY26. The yield on the benchmark 10-year paper, which serves as the basis for pricing of corporate loans, closed on Tuesday at 6.49%, the highest since early April.
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The central bank kept rates on hold and continued with a 'neutral' monetary policy stance last week. While this was expected, the absence of dovish stance along with RBI's inflation forecast of 4.9%-higher than its medium-term target-for the first quarter of next fiscal year dampened hopes of rate cut in October unless there is a sharp growth shock-whether domestic or external. Last week, the RBI retained the growth projection at 6.5%. "The combined fear of the rate cut cycle ending and a higher fiscal deficit-caused by weaker revenue and easing measures to support sectors hit by tariffs-has soured sentiment for the market," said Abhishek Upadhay, economist at ICICI Securities Primary Dealership.
Bond dealers said the spread between the 10-year yield and the repo rate was lower in early 2025 because RBI's open market operations skewed the demand-supply balance in favour of bonds as the central bank absorbed much of the supply. The current widening of the spread should also, therefore, be viewed in the context of the absence of this demand.
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