By V. Ramakrishnan and Rajkumar Ray MUMBAI/NEW DELHI (Reuters) - Fears of a deep U.S. recession and stubbornly high inflation spooked India's jittery markets on Thursday, while its biggest lender led a round of rate cuts following aggressive moves to bolster growth by the Reserve Bank. The BSE Sensex fell 3.8 percent to its lowest close in a week, caught in a broad global sell-off sparked by concerns over faltering major economies. Stocks recovered most of their losses in afternoon trade on expectations annual wholesale price inflation would fall substantially from a week earlier, but the release of a higher figure sent shares into a dive. "It's going to be pendulum-like trading for sometime," said K.K. Mital, head of portfolio management services at Globe Capital. "Global concerns still remain. Every day we are hearing this guy is cutting production, that guy is cutting jobs ... so people are booking profits." Government data showed the wholesale price index, India's most widely watched price measure, rose 10.72 percent in the 12 months to Oct. 25, above forecasts for a rise of 10.45 percent and up from the previous week's rate of 10.68 percent. But analysts saw inflation continuing its downward trend and hitting single digits by December. "We view this as a one-off ... and expect inflation to keep falling," said A. Prasanna, an economist at ICICI Securities. "We see it dipping into single digits in the next couple of readings and falling to below 5.5 percent by March 2009." Heavy losses in the share market raised worries of further foreign fund outflows and undermined sentiment for the rupee , which ended 0.4 percent weaker at 47.66/69 per dollar. Tight cash conditions last month forced some Indian banks to borrow at exorbitant interest rates and froze money markets, prompting policy makers to unveil a slew of measures, including cuts to rates and banks' reserve requirements to free up funds. India's authorities joined others around the world who have slashed interest rates in recent weeks and injected huge amounts into their banking systems to combat the spillover effects of the global financial crisis. LENDERS FOLLOW RBI LEAD A softening in inflation from a peak of 12.91 percent in early August has given the Reserve Bank room to cut rates to ease the cash squeeze and protect growth, which is expected to slow to 7 percent this year from 9 percent in 2007/08. The Reserve Bank of India slashed it main short-term lending rate by 150 basis points in two moves on Oct. 20 and Nov. 1. The rate now stands at 7.5 percent. Overnight call money, the interest rate banks charge each other, eased to 6.20/6.40 percent from 6.75/7.00 percent on Wednesday. In a further sign cash conditions had improved, the RBI absorbed a net 306.3 billion rupees ($6.4 billion) from banks at its money market operations -- a sharp turnaround from huge liquidity injections seen in October. Several state-run banks cut interest rates with No. 1 lender State Bank of India trimming its main lending rate by 75 basis points. Its chairman, O.P. Bhatt, said it would also raise $1-$2 billion this year to help tide over tight liquidity conditions. Bhatt said lack of liquidity was a big issue in the country's banking system, and also warned the sector's bad loans would rise because of the stress in the economy. "In India we don't have the problem of a lack of trust between banks and financial institutions, but we do have a problem of lack of liquidity," he said. "There is not enough liquidity in the system for money to flow from one bank to another, or from one bank to a customer." Bhatt said there would be further pressure on liquidity as some funding avenues, such as offshore loans and foreign direct investment, had dried up or been largely reduced. But he added: "As long as the authorities are aware, as long as they are proactive about it, I don't see any difficulty in their managing liquidity positively." (Additional reporting by Devidutta Tripathy in NEW DELHI and Kaustav Roy in MUMBAI)

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