By Suresh Seshadri and Annapurni Hariharan

PUNE, India (Reuters) - Reserve Bank of India chief said on Wednesday no unexpected events had occurred since a short-term interest rate rise in April to warrant a review of monetary policy.

The comment sent bond yields to fresh two-month lows, with the yield on the popular 12-year bond easing to 6.8852 percent from 6.8971 percent, as investors grew more confident rates would not rise at the next policy review in July.

Speaking to reporters on the sidelines of a banking school convocation, Yaga Venugopal Reddy also said he did see excessive speculation in local financial markets right now, just weeks after a ban of a hedging tool used to bet on the currency.

Reddy said as far as the exchange rate was concerned, the central bank's policy of checking huge swings remained the same.

"If we see excessive volatility or speculation, that is the only time we have to take special notice," he said in the western city of Pune. "Now I think overall in all the markets, we don't see any particular excessive speculative activity."

His comments come just weeks after the central bank moved to phase out a foreign interest rate benchmark for pricing interest rate derivatives, the MIFOR, in favour of a domestic benchmark. The foreign benchmark can only be used on interbank deals.

By removing the foreign element in the swap, the central bank was trying to take away a tool used to place bets on the dollar/rupee rate and extend its control over the rupee.

Reddy had voiced concerns in January about volatility caused by foreign fund activity in India's financial markets and argued that an option to cap them must be considered.

Big inflows into equities drove the rupee 5 percent higher in 2004, prompting the central bank to step in to slow its rise.

Analysts estimate the partially convertible rupee is 7 percent overvalued on a trade-weighted basis, and it was quoted near two-week highs of 43.5125/5250 per dollar after Reddy spoke.

BONDS YIELDS

Asked if the central bank was comfortable with a recent rally in federal bond prices, Reddy said yields were market determined. While uncertainty remained on oil, India's biggest import and an inflationary danger, fears of a rapid price rise had moderated.

Badrish Kulhalli, fund manager at Alliance Capital Mutual Fund, said the comment indicated there may not be any rate increases in the near future.

"The last two rate increases were more preemptive in nature in the face of rising inflation," he said.

The central bank raised the benchmark reverse repo rate by 25 basis points to 5.0 percent in April, after a similar-sized rise in October as inflation eased off a 3-1/2-year peak of 8.74 percent. Wholesale price inflation stood at 5.38 percent in the 12 months to May 21, down from 5.55 percent the week before.

Reddy praised a government focus on the fiscal deficit which stood at 4.1 percent of gross domestic product in the year to March 2005, well below the government's 4.5 percent target.

"The finance minister has been looking at the whole issue of fiscal deficit and this makes the monetary policy and fiscal policy coordination far more smooth and far more positive."

Reddy expected manufacturing output to remain robust, leading to steady demand for loans from banks to fuel investment in Asia's fourth-largest economy.

But he said the central bank was closely watching the southwest monsoon, a key to farm output and domestic demand for goods and services. Farms generate nearly a quarter of GDP.

(additional reporting by Atiya Hussain in BOMBAY)