OREANDA-NEWS. February 03, 2015. India's one-year swap rates plumbed their lowest levels in more than 1-1/2 years on the eve of the Reserve Bank of India's policy review, reflecting expectations the central bank will cut rates aggressively after unexpectedly easing policy last month.

The 1-year overnight index swap (OIS), which reflects bets on rate movements, hit a low of 7.41 percent on Monday, its lowest since July 5, 2013.

That extended a rally begun after the RBI unexpectedly cut its key lending repo rate by a quarter percentage point to 7.75 percent in mid-January.

According to traders' calculations, swaps markets are now pricing in 100-125 bps of additional rate cuts over the next year, including a 25 bps cut at Tuesday's policy review.

Bond markets, however, were far more conservative, pricing in about 75 bps in cuts over the year, traders said.

Some traders fear the move on swaps could be overdone, and any setback to expectations could spark a steep correction.

"I don't see too much of logic in there. It's pure momentum which people trade," said Ashish Vaidya, head of trading asset-liability management at DBS in Mumbai.

The 5-year OIS has rallied since the RBI rate cut, touching a low of 6.72 percent last Wednesday, its lowest since May 21, 2013.

Offshore traders expect even more rate cuts, with the offshore non-deliverable 5-year OIS trading half a percentage point lower at 6.25 percent.

The expectations stand in contrast with the views of analysts polled by Reuters, who do not expect a cut on Tuesday and believe the RBI will deliver only 75 bps or less in rate cuts over the next year.

Only three out of 45 analysts polled expect as much as 100 bps over the next year.

The RBI has made clear that future rate cuts will partly depend on the government delivering "high quality fiscal consolidation," starting at its fiscal budget due on Feb. 28.

But analysts warn that India's traditionally volatile inflation could tie the RBI's hands on rates.

Food prices - the biggest component of consumer prices - are highly influenced by unpredictable monsoon rains, and that has contributed to policy reversals by the RBI in the past.

"The minute there is a signal that the rate cutting cycle is over or if the central bank starts to get more cautious, the rise in OIS will be as steep as the fall, as the entire move is exaggerated," warned the head of fixed income trading at a foreign bank.