The Indian rupee edged lower on Tuesday as a sharp easing in wholesale price inflation raised optimism the central bank would cut interest rates to boost economic growth, but gains were short-lived as the dollar remained well bid in the local market.
Headline inflation fell below 5 percent in April, dropping within the central bank's comfort zone for the first time in more than three years and fuelling hopes the Reserve Bank of India would continue its easing campaign.
However, the rupee still remains constrained by other factors, including concerns the current account deficit will widen after data on Monday showed a spike in the trade deficit due to a jump in gold and oil imports.
"The inflation data was a huge positive and prompted foreign banks to sell the dollar. Later there was some small demand (for dollars) coupled with a short market which pushed the rupee off highs," said Ashish Barua, a senior forex dealer at IndusInd Bank.
"The rupee should continue to trade in a range in the near-term, 55 to 55.10 should be capped on the topside while 54.25-54.30 will be the floor for USD/INR," he added.
The partially convertible rupee closed at 54.81/82 per dollar compared with 54.73/74 on Monday. The pair moved in a wide 54.53 to 54.83 range during the session.
The index of the dollar against six major currencies was trading up 0.1 percent.
Prospects of rate cuts by the RBI - which has eased the repo rate by 75 bps so far this year - help the rupee by increasing confidence in growth and spurring hopes of gains in domestic shares.
India's stock indexes edged higher on Tuesday, recovering after posting on Monday their biggest daily percentage falls in around a year.
The onshore forwards also saw some receiving on the back of rate cut bets. The one-year onshore forward premium fell to 333.25 points from 340.50 points on Monday.
In the offshore non-deliverable forwards, the one-month contract was at 55.04 while the three-month was at 55.53.
In the currency futures market, the most-traded near-month dollar/rupee contracts on the National Stock Exchange, the MCX-SX and the United Stock Exchange all closed at around 54.94 with a total traded volume of $4.8 billion.