Indian bonds at 20-month’s highs, rupee gains after surprise rate cut

MUMBAI, March 4 (Reuters) - Indian government bonds surged to their highest in nearly 20 months while the rupee jumped to a one-month high on Wednesday after the central bank lowered interest rates, in a move that came earlier than expected.

India's central bank lowered its key policy repo rate by 25 basis points to 7.5 percent, its second inter-meeting cut this year on the back of easing inflation and what it said was the "weak state" of parts of the economy.

The move was also seen as backing the government's budget unveiled on Saturday, which pledged fiscal responsibility but delayed meeting a fiscal deficit target of 3 percent of gross domestic product by a year to fiscal year 2017/18.

The Reserve Bank of India caught markets off guard, just as it did in January when it made the last interest rate cut, as traders had expected the central bank to wait until a scheduled policy review on April 7.

"I think the RBI clearly viewed the budget as more positive than the markets," said Kumar Rachapudi, a senior fixed income strategist at ANZ Bank based in Singapore.

"If this is an indication of the confidence the RBI has in the government and vice-versa, I think the medium term lower rates story has a fair way to go. We continue to advocate long positions in 10 year bonds," he added.

The benchmark 10-year bond yield was trading at 7.67 percent by 0614 GMT, after hitting 7.6060 percent earlier, its lowest level since July 15, 2013.

Market participants say they now expect the next RBI rate cut to come after its scheduled April policy review, likely around the next meeting in June, unless consumer inflation unexpectedly picks up.

Traders and analysts are broadly predicting the 10-year yield will drop towards 7.25 percent over the next six to eight months.

The partially convertible rupee also gained to a one-month high of 61.65 to a dollar but central bank intervention pulled the rupee back to 61.85/86 levels. The rupee had ended Tuesday at 61.9150/9250.

In the overnight indexed swap markets, the one-year rate fell sharply to 7.50 percent, its lowest level since February 3, in an immediate knee-jerk reaction to the budget. It was last trading at 7.55 percent versus Tuesday's 7.76 pct.

The benchmark five-year swap rate dropped to as much as 6.92 percent from Tuesday's close of 7.10 percent. It was last trading at 6.95 percent.