Rising inflation will keep Indian stocks from making significant gains this week while bonds are expected to rise after the central bank last week allowed banks to defer booking paper losses on federal bond investments.
Shares gained 2 percent last week, boosted by newly listed Tata Consultancy Services Ltd, but were unlikely to rise much further in the run-up to the earnings season next month, traders said.
The 30-share Bombay Stock Exchange index has traded in a broad 200-point range since August and this trend was likely to continue this month, they said. Last week's gain came despite data that showed inflation rose to a three-and-a-half year high of 8.17 percent in the year to August 21 on higher energy and food prices.
Shares of state-run banks, among the biggest investors in federal bonds, are also seen gaining from the central bank's move to relax rules governing their investment portfolios to cushion them from huge losses from a recent spike in government yields.
Prices of crude oil, India's biggest import item, firmed above $44 a barrel last week on fresh attacks in Iraq, raising concerns it will further drive up local and put upward pressure on interest rates.
Apart from this central bank directive, traders say bonds would get a further fillip if the federal government decides to borrow funds this week through an issue of short-dated securities or floating rate bonds.
According to the central bank's issuance calendar, the government will issue two bonds between September 2 and 9. One will have a 5-to-9 year maturity for 60 billion rupees. The other will be in the 15-to-19 year segment for 40 billion rupees.
A floating rate bond is treated like a short-dated security as it is usually benchmarked to a 364-day treasury bill and is used by banks to hedge in an uncertain interest rate environment.
The yield on the benchmark 10-year bond ended at a one-and-a-half-month low of 5.8823 percent on Saturday, down from 6.0260 a week earlier and nearly 77 basis points off an 18-month closing high of 6.6519 percent on August 12.
Yields had risen to multi-month highs on fears of monetary tightening and inflationary pressures.