Indian bonds are likely to rebound slightly from their sharp drop on a surprise spike in inflation, while stocks may remain dull as investors await the budget on July 8, traders said.
The surge in inflation had undermined sentiment in the bond market, but the sell-off was probably overdone, some traders said. Government data released on Friday showed wholesale prices rose 5.55 percent in the year to June 5, much higher than analysts' forecast of 5.08 percent.
That pushed the 10-year benchmark bond yield above 5.50 percent for the first time since August 22. "Yields probably rose too high, too fast," said Siddharth Mathur, a strategist at J.P. Morgan Securities.
"So while broad sentiment is still weak, I expect some buying here and there, mainly by state-run banks, to keep the 10-year drifting in a 5.40-5.50 percent range this week."
The 10-year bond recovered some ground on Saturday after some large cash-flush state-run banks chose securities that had been beaten down. Its yield finished 14 basis points higher on the week at 5.4671 percent.
"Some buying is emerging at lower levels, so prices should consolidate. This week's inflation data should be the next cue," said S.P. Prabhu, analyst at IDBI Capital Market Services Ltd.
But the medium-term outlook for bonds is still fairly bearish because analysts expect the Indian central bank to raise rates in response to rising inflation and the US Federal Reserve's expected rate increase at the end of the month.
The Reserve Bank of India had left rates at three-decade lows last month, but signalled a shift in stance to neutral from soft.
The view that domestic rates have bottomed has begun to push up yields, with the 10-year now 52 basis points higher than its term low of 4.9442 percent in mid-October.
Dealers said there could be some buying in tech shares in otherwise dull trade this week after a recent weakening in the rupee. Many software exporters' profit forecasts were based on a stronger rupee, they said.
Volumes are expected to remain low until the government presents its budget, shedding more light on how it proposes to carry out its economic policies, analysts said.
"The markets are still going to be dull. It's too early for whatever pre-budget rally there may be. The upside is capped," said Ambareesh Baliga, vice president at Karvy Stock Broking.
Despite assurances from a reformist finance minister, investors are nervous that the Congress-led government will be under pressure from communists to go slow on economic reform and from coalition partners to announce costly populist measures.
The average daily volume on the Bombay Stock Exchange has dropped to half the level seen earlier this year after the government took power with outside support from communists, following a surprise election win in mid-May.
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