MUMBAI (Dow Jones)--India government bonds ended lower Thursday after the central bank lifted the key borrowing rate more forcefully than expected and hiked the key lending rate in-line with estimates in a bid to quell high inflation. The Reserve Bank of India hiked its repo, or lending, rate by 25 basis points to 6.00% and the reverse repo, or borrowing, rate by 50 basis points to 5.00%. The benchmark 7.80% 2020 bond recovered most losses to end at INR98.90, after falling to an intraday low of INR98.70 after the rate hikes. Wednesday, it closed at INR99.02. RBI said that inflation remains the dominant concern in macroeconomic management, stubbornly staying over the trend of 5.0%-5.5% in the 2000s. "There is, therefore, need for continued policy response to contain inflation and anchor inflationary expectations," the central bank said. Finance Minister Pranab Mukherjee said the rate hikes was a step in the right direction, showing the government's support for the move, as inflation has become an uncomfortable political issue. "I think adjustment of repo and reverse repo (rates) will help in the mop-up of additional liquidity, which is putting pressure on the system," Mukherjee said. Overnight indexed swap rates surged after market participants were caught off-guard on the higher-than-anticipated reverse repo rate hike. The near-ends surged more as the RBI said it will keep the repo rate as the effective policy rate, signalling tight liquidity. The 1-year OIS rose to 6.36%/6.39% compared to Wednesday's close of 6.20%/6.23%, while the 5-year OIS increased to 7.06%/7.09% from the previous close of 6.99%/7.01%. "Today's 50 basis point reverse repo hike had a mild shock element," said Manish Wadhawan, head of interest rates at HSBC Global Markets, India. "From here onwards, the other factors that will become important in deciding the yields in the long-end (bonds) would be supply, liquidity, deposit creation and, on account of that (deposit growth), how much demand for bonds comes in." He expects the 10-year benchmark yield to trade in 7.90%-8.10% for the next six weeks. In the currency market, the Indian rupee gained to an over five-week high against the U.S. dollar, mirroring the euro's gains and also as big foreign banks were seen selling the greenback after RBI's rate hikes. The dollar was at INR46.15 late Thursday, down from INR46.36 Wednesday. "We believe that USD/INR will continue to grind lower from here on reduced trade deficit concerns, India's positive economic outlook, and the possibility of additional stimulus from the U.S. and China," Standard Chartered said in a research note. However, "global factors pose the key risks to our bullish rupee outlook, as a sharper-than-expected growth slowdown would impinge on capital inflows and, in turn, the Indian rupee," the note added. The house tips traders to go long on the rupee against an equally-weighted EUR/USD basket. -By Khushita Vasant, Dow Jones Newswires; +91-22-6145-6115; khushita.vasant@dowjones.com

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