Rupee outlook positive, central bank eyed; bond yields likely to rise

FILE PHOTO: A broker reacts while trading at his computer terminal at a stock brokerage firm in Mumbai

By Nimesh Vora and Dharamraj Dhutia

MUMBAI (Reuters) - The Indian rupee is likely to rise further this week on the back of a struggling U.S. dollar but traders were inclined to be wary of possible dollar-buying intervention by the Reserve Bank of India (RBI) that could limit sharp gains.

Government bond yields are expected to tick up as investors shift focus to the upcoming budget.

The rupee climbed 1.7% to 81.3250 per dollar last week, tracking a broad decline in the dollar index. The local currency is expected to trade between 80.80 to 81.70 this week.

The slowdown in the U.S. inflation rate for the sixth straight month in December has prompted investors to pile on to bets that the Federal Reserve will hike rates by 25 basis points (bps) at the next meeting.

There are a lot of positives for the rupee, including the Fed view, the broadly stable oil prices and the fall in Treasury yields, said Anil Bhansali, head of treasury at Finrex Treasury Advisors.

"Accordingly, USD/INR should be headed to 80.50. However, let's see if RBI allows this or it once again chooses to rebuild reserves."

Meanwhile, Indian government bond yields may inch higher after a decline in the previous week, as investor focus is expected to shift to worries over an announcement about elevated borrowing in the federal budget, due to be presented on Feb. 1.

The benchmark government bond yield ended at 7.3003% on Friday, down 7 bps last week, its biggest such move in six weeks amid easing inflation.

Market participants have so far pegged gross borrowing above 15.50 trillion rupees for the next fiscal, and this may continue to put upward pressure in the run up to the budget. The yield is expected to move between 7.28%-7.35% during this week.

"Budget would be the main trigger for government bond market. Till then, bond yields should not fall much, as most people are expecting a heavy borrowing calendar," said Ajay Manglunia, managing director and head of investment grade group at JM Financial.

Meanwhile, as a bulk of the fresh supply for the next financial year would hit the longer end, market participants expect yields to rise, while shorter-tenor yields may see some fall.

KEY EVENTS:

* India Dec WPI inflation - Jan 16, Monday (12:00 p.m. IST) * China Q4 GDP - Jan 17, Tuesday (07:30 a.m. IST) * China Dec industrial output - Jan 17, Tuesday (07:30 a.m.IST) * U.S. Dec retail sales - Jan 18, Wednesday (7:00 p.m. IST) * U.S. Dec industrial production - Jan 18, Wednesday (7:45p.m. IST) * India Dec trade data - Jan 10-17

(Reporting by Nimesh Vora and Dharamraj Dhutia; additional reporting by Anushka Trivedi; Editing by Janane Venkatraman)