Although markets had been widely pricing in a RBI rate cut, most investors had expected the central bank to move either at its policy review on Feb. 3 or sometime after the government unveiled its annual budget at the end of February.
Instead traders were caught off guard, as the RBI cut its repo interest rate by 25 basis points to 7.75 percent, citing easing inflation and government efforts to contain the fiscal deficit.
"The statement was dovish in our view and with the disinflationary trend being strong, we see room for a further rally in bonds, in line with our economists forecast of more repo rate cuts," strategists at Barclays wrote in a note.
"We revise our 10 year government bond year-end target lower to 7.25 percent from 7.40 percent previously and continue to recommend being overweight duration in government bonds."
The rate cut pushed the benchmark 10-year bond yield to 7.65 percent, down 12 basis points on the day and its lowest level since July 15, 2013.
Meanwhile, in the overnight indexed swap market, the one-year rate dropped as much as 13 bps to 7.50 percent, its lowest since July 15, 2013, which traders said priced in the prospect of cuts of around a further 75 bps over the next year.
"In OIS - we think the flattening trend has most likely come to an end. The curve will steepen. The pace of steepening will be dependent on how aggressive RBI is," said Kumar Rachapudi, a fixed income strategist with ANZ Bank in Singapore.
Stocks rallied with the Nifty gaining more than 2 percent in early trade, while the rupee partially convertible rupee gained to as much as 61.71, its strongest level since Nov. 24.
The NSE Bank index rose as much as 4.3 percent to a record high of 19,410.40 points.
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