WEEKAHEAD-Indian rupee’s recovery, bond yield’s direction hinges on RBI, US inflation

By Nimesh Vora and Dharamraj Dhutia

MUMBAI, Aug 7 (Reuters) – The Indian rupee’s recovery from the two-and-half-month low it hit last week and the direction of government bond yields will depend on U.S. inflation data and the Reserve Bank of India’s policy outcome.

The rupee INR=IN ended at 82.84 on Friday, having declined 0.7% last week, its biggest drop since the week ending July 7.

The currency is expected to have a quiet beginning to the week following the U.S. jobs report.

U.S. nonfarm payrolls increased by 187,000 jobs last month, below economists’ expectations. Average hourly earnings, however, surprised on the upside, rising 4.4% from a year earlier, and the unemployment rate edged down to 3.5%.

Whether the rupee is able to mount a recovery later in the week will likely depend on U.S. consumer inflation data due Thursday. An in-line or a softer-than-expected reading will reinforce expectations that the Federal Reserve will not hike interest rates further.

This, in turn, would cool off the recent rally in U.S. yields — on expectations rates will stay higher for longer — helping the rupee and other Asian currencies.

The RBI’s rate decision is also due on Thursday and while economists expect the central bank to maintain the status quo, its commentary on inflation will be the trigger.

“The recent surge in food price inflation means the RBI’s policy decision is now less of a formality than it had appeared,” Capital Economics said in a note.

“On balance, we still think that the RBI will keep the repo rate on hold at 6.50% rather than resume tightening.”

The benchmark 7.26% 2033 bond yield IN072633G=CC ended at 7.1915% on Friday. It rose three basis points (bps) last week, after rising eight bps the week before.

The recent climb in yields is due to the spike in U.S. yields and concerns that local retail inflation may jump sharply in the near term, forcing the RBI to take a more hawkish stance.

Traders expect the benchmark bond yield to be in the 7.13-7.23% zone till the monetary policy meeting.

Kotak Mahindra Bank said the RBI’s concerns will increase as inflation creeps back above 6% and even though the sharp increase in prices of select items may be transitory, the RBI will be wary of the impact of high food prices on inflation expectations.

“Given the renewed upside bias to headline inflation, the RBI will have to remain hawkish until inflation reverts to a more comfortable zone,” chief economist Upasna Bhardwaj said.

“Having explicitly shifted to guide inflation toward the 4% target, there is limited room for the RBI to sound dovish.”

KEY EVENTS:

** U.S. June international trade – Aug 8, Tuesday (6:00 p.m. IST)

** India policy rate decision – Aug 10, Thursday (10:00 a.m. IST)

** U.S. July CPI – Aug 10, Thursday (6:00 p.m. IST)

** U.S. initial weekly jobless claims – Aug 10, Thursday (10:00 a.m. IST)

** India June industrial output – Aug 11, Friday (5:30 p.m. IST)

(Reporting by Nimesh Vora and Dharamraj Dhutia; Editing by Savio D’Souza and Eileen Soreng)

((nimesh.vora@thomsonreuters.com; +91 22 6921 7896;))

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