RBI’s policy signals are leading to a softening of interest rates
As highlighted by Puneet Pal, the RBI has sharply cut its FY26 inflation forecast to 2.6% – over 100 basis points below its June projection – while simultaneously upgrading its GDP growth outlook to 6.8% from 6.5%. The combination of favorable inflation expectations and improved growth sentiment supported the decline in interest rates.While monetary policy remained officially “neutral,” two MPC members – Dr. Nagesh Kumar and Prof. Ram Singh favored a shift to an ‘accommodative’ stance, adding to optimism in the bond market.
Rupee weakness draws rare RBI commentary
In an unusual move, the RBI Governor also commented on the rupee’s weakness, noting periods of depreciation and volatility. As explained by Puneet Pal, this prompted the RBI to actively intervene in both the spot and forward markets to stabilize the currency. However, these interventions depleted the liquidity of the system and put upward pressure on money market yields, despite the liquidity injection resulting from the 50 basis points cut in the CRR.
Even then, optimism over possible future rate cuts, coupled with relief over fiscal stability – especially as GST rationalization is not expected to lead to additional borrowing – helped G-Sec’s performance during the month.
Inflation is at multi-year lows
India’s CPI inflation fell to an eight-year low of 1.54% in September, averaging 1.7% for the quarter – below the RBI’s own forecast. Puneet Pal noted that while food inflation remained subdued, core inflation rose to 4.6% on higher gold prices and an unusual month-on-month spike in housing inflation. The core CPI (excluding food, fuel, gold, petrol) remained at 3.3%, suggesting underlying pressures may ease if VAT is cut.
Given the sharp disinflation trend, Puneet Pal believes the RBI may further reduce its inflation target in the next MPC meeting.
The yield curve steepens as longer-term demand weakens
Despite the announced lower long-term loans for the second half of the year, the yield curve steepened in October. Interest rates fell broadly in the first half of the month, but a weak auction at the long end revived concerns about supply and demand pressures.According to Puneet Pal, longer-dated yields ended the month flat to slightly higher, while the benchmark 10-year bond closed 5 basis points lower at 6.53%.
He adds that verbal commitments from the RBI may not be enough, and markets are increasingly expecting OMO purchases to address tight liquidity and stabilize the longer end of the curve.
RBI is expected to initiate OMO purchases
With banks’ liquidity declining due to higher currency in circulation and continued currency intervention, Puneet Pal expects the RBI to start OMO purchases next quarter. This will likely be crucial for balancing the dynamics between supply and demand, especially for longer maturities.
The rupee ended October at 88.77 – close to all-time lows – despite active market intervention from the RBI.
Strong FPI inflows are supporting the bond market
Foreign investors continued to show strong interest in Indian debt, bringing in $1.97 billion in October, bringing inflows since the beginning of the year to $8.16 billion. This is in stark contrast to the equity markets, which saw sustained FPI outflows in 2025.
CD rates remained stable, with three-month CDs at 6.00–6.05% and one-year CDs at 6.40–6.50%. The OIS curve flattened, with the 5-year OIS at 5.67% and the 1-year slightly higher at 5.47%.
Globally, the easing of US interest rates provided additional support as the Federal Reserve cut rates again, although future rate cuts remain data-dependent.
Outlook: range-based returns in prospect
According to Puneet Pal, the bond market is starting to accept that India is nearing the end of its rate cutting cycle, although another cut cannot be ruled out. However, unfavorable long-term supply dynamics continue to weigh on sentiment.
Looking ahead, he expects 10-year G-Sec yields to trade within a narrow range of 6.30%–6.70% in the coming months, with Sovereign Development Loans (SDLs) likely to outperform in the medium term.
(Disclaimer: Recommendations, suggestions, views and opinions expressed by the experts are their own. These do not represent the views of The Economic Times)
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