Indian government bonds ended higher on Monday after stronger-than-expected demand at the central bank's debt sale, although gains were capped by elevated U.S. Treasury yields and rising expectations of a rate hike next month by the Reserve Bank of India.

The RBI sold bonds worth 250 billion rupees ($2.61 billion) earlier in the day, with the cut-off yields below market estimates, indicating a rising demand for these securities.

The benchmark 6.94% 2036 bond yield ended at 7.0497%, down from 7.0686% on Friday.

Still, bets that the RBI will further withdraw liquidity from the banking system, followed by a repo rate hike on October 7, kept a lid on any runaway rally.

The liquidity surplus has narrowed to 6.05 trillion rupees down from a record 11 trillion rupees reached earlier this month.

The RBI is also facing pressure from a tightening global rate environment, with major central banks such as the Federal Reserve, European Central Bank and the Bank of Japan signalling further rate increases to contain inflation.

That shift pushed global yields higher, with the 10-year US Treasury yield at 5%, a level last seen during the 2008 financial crisis.

"The external rate environment has turned less supportive. Higher US yields, elevated crude, and RBI liquidity absorption are reinforcing each other, limiting the scope for a meaningful decline in Indian bond yields," Motilal Oswal Financial Services said in a note.

"The August CPI print remains manageable, but the forward risks have increased materially. We expect the combination of elevated food prices and energy pressures to push CPI inflation above 6% in October-December."

RATES

Overnight indexed swap rates inched slightly down, with lower oil prices.

The one-year rate ended at 6.07%, while the two-year rate was at 6.2850%, and the five-year rate closed at 6.5425%.