After rising through the week, bond yields shot up to a one-year high of 8.24% on Friday. Fears of monetary tightening dominated market sentiment, after RBI governor YV Reddy said on Thursday that the central bank was ready to take recourse to its complete range of instruments to allay inflationary expectations.

Yields on the 10-year benchmark bond, the 8.24% paper maturing in 2018, ended the day at 8.23%, above the Thursdays close of 8.19%. The days high of 8.24% was also the highest level the bond has seen since it was issued in April this year.

Traded volumes remained thin, as dealers remained wary of what the next few weeks have in store. A dealer with a private bank said, "The governors statement was the confirmation that the rumours of a rate hike lacked."

The market has been expecting a hike in the repo rate - the rate at which banks borrow from the RBI - ever since the fuel price hike raised expectations of inflation crossing the 9%-level. Further, market participants do not see yields coming down from these levels any time soon.

"With liquidity set to come under strain next week after Fridays auctions and advance tax outflows, we could well see yields heading towards the 8.5%-mark," said a senior official with a bond house. The RBI auctioned Rs 10,000 crore of two government securities on Friday. It also announced that Rs 3,500 crore of treasury bills will be auctioned on Wednesday.

However, liquidity remained comfortable on Friday, with banks parking surplus funds worth Rs 22,025 crore with RBI through reverse repo operations of its liquidity adjustment facility. Meanwhile, the rupee rose after the market experienced lesser demand from oil companies.

RBI had announced last week that it would directly sell dollars to oil companies, in exchange for oil bonds. The move was aimed at easing dollar demand from oil companies which had pulled the rupee down over the past month.

According to dealers, some action from RBI appears imminent considering that the rate of inflation is the same as the yield on 10-year g-secs.

"If inflation continues to remain high real interest rates will turn negative. Money supply growth at 22.5% is also way beyond RBIs comfort level," said a dealer adding that the central bank is likely to come out with monetary measures to keep inflation in check.

The central banks decision to sell dollars directly to oil companies has helped to provide support for the rupee. The rupee ended the day at 42.66/67 against the dollar, rising from Thursdays close of 42.90/91.