India's benchmark 10-year bond yield dropped to its lowest...

India's benchmark 10-year bond yield dropped to its lowest level in two and half months on Friday, tracking the drop in its U.S. counterparts, while the rupee strengthened to its highest in nearly three weeks in response to broad dollar losses.

The 10-year bond yield IN065432G=CC was trading at 7.2645% by 0506 GMT, after falling to 7.2527% earlier, its lowest since May 12. It had ended at 7.3316% on Thursday.

The partially convertible rupee INR=D3 was trading at 79.43/44 to the dollar, stronger than Thursday's close of 79.7550. In early trade it rose to a high of 79.34, its strongest since July 11.

The dollar languished near a six-week low against the yen amid a sharp retreat in Treasury yields after investors interpreted a shrinking U.S. economy as one more reason for the Federal Reserve to ease off the tightening pedal.

Most Asian currencies also rose against the dollar.

The domestic share markets .NSEI and .BSESN were both trading up around 0.5% each.

"With the Fed having stuck to a 75 bps hike and concerns of a global recession still looming, the RBI may announce a modest 25-35 bps increase in the repo rate next week," a senior trader at a private bank said.

"We will see the 10-year move in a 7.20% to 7.35% range until (then)," he added.

U.S. Treasury yields fell overnight after data showed the economy contracted again in the second quarter, suggesting that the Federal Reserve may not need to be so aggressive to cool inflation.

"We expect the RBI's monetary policy committee to vote unanimously for a 35 bp rate hike during next week's policy review meeting," economists at Barclays said in a note.

"While inflation is likely to remain elevated in the near term, we think the MPC may acknowledge that price pressures have peaked, and note the favourable tailwinds by reducing its inflation forecasts, albeit marginally," they added.

India's retail inflation remained painfully above the 7% mark and beyond the central bank's tolerance band for the sixth month in a row in June but has shown an easing bias over recent months.