India bond yields may jump on central bank's "Damocles sword" plan of auction sales

By Dharamraj Dhutia and Bhakti Tambe

MUMBAI (Reuters) - India's benchmark 10-year bond yield posted its biggest one-day jump in 17 months on Friday, with overall bond yields expected to rise further, on the Reserve Bank of India's plan of open market sales of bonds via auctions.

The 10-year yield rose to 7.3645%, with the 15 basis points increase its biggest single-session rise since May 4, 2022.

The surge came after RBI Governor Shaktikanta Das said, while announcing monetary policy, the central bank plans to auction bonds via open market operations (OMO) to manage liquidity.

"The use of the OMO sales tool to manage the liquidity is a big disappointment and has spooked the bond market. This Damocles sword hanging over will keep yields higher," said VRC Reddy, treasury head at Karur Vysya Bank.

The RBI has been selling bonds via screen-based operations for the past few weeks, to drain additional liquidity, since it started phasing out incremental cash reserve ratio.

It sold bonds worth 71 billion rupees ($853 million) in four weeks to Sept. 22.

The RBI does not currently plan to give a calendar for the sales and that uncertainty over the timing of these, said economists, will dominate sentiment and keep yields elevated.

"I think it is about to what extent the RBI is willing to go to manage inflationary expectations," said Naveen Singh, head of trading at ICICI Securities Primary Dealership.

"The (10-year) yield can easily go from 7.30% to 7.50% if the RBI is ready to sell bonds at 7.50%. The market will keep asking for higher levels and the levels at which RBI starts rejecting, we should see some consolidation," Singh said.

"When the central bank is showing an intent that the yields are lower and they want to take out the durable liquidity and the curve is flat, then the market will ask for higher yields." ($1 = 83.2325 Indian rupees)

(Reporting by Dharamraj Dhutia; Editing by Savio D'Souza)