The BSE Sensex jumped 443 points or 2.5 per cent to close at 18,441 while the broader Nifty advanced 142 points to 5,578 amid a global rally Friday. This was the biggest one-day gain for the Sensex since December 21, 2012 and the highest close for markets since July 2011.
The latest trigger for the rally was the government's decision to hike diesel prices. The US Federal Reserve's decision to launch a third round of quantitative easing (new asset purchase programme) sent stocks soaring worldwide.
The Fed said it would buy $40 billion of mortgage securities a month until the US economy improves. Fed's decision would lead to a rise in liquidity in the global economy giving a push to riskier assets like equities and commodities.
The government's decision to hike diesel prices raised hopes that reforms might be back on tracks. The cabinet's economic panel is due to meet later today to discuss a plan to invite foreign airlines to invest in domestic carriers and a proposal to sell shares of large state-run firms. All these developments point to a decisive shift in the government's thinking on the economy, analysts said.
"Fuel price announcements coupled with positive global news flows will provide another boost to markets. This rally should continue in near term," Jagannadham Thunuguntla, head of research at SMC Investments and Advisors told Reuters.
Traders overlooked a higher than expected print in headline inflation, which dims the prospects of a rate cut next week.
The BSE banking index gained 4.1 per cent on expectations that the fuel price hike would increase the prospect of rate cuts, given Reserve Bank of India officials were seen as wanting the government to shore up its finances before considering easing monetary policy. State Bank of India rose 5.6 per cent, while ICICI Bank rose 5.1 per cent.
Shares in software services exporters and metals rose after the Fed launched an aggressive stimulus program to kick start the US economy.
Tata Steel rose 4.5 per cent; Hindalco Industries jumped 8 per cent, while Infosys advanced 3 per cent. Market bellwether Reliance Industries rose 5.3 per cent.
Airlines rose on hopes that the sector would benefit from a potential opening up of the sector. SpiceJet extended gains for a third day, up 4.5 per cent.
Despite strong gains, analysts say it will not be one-way street for the markets.
"We may see aviation and retail FDI in coming weeks and if the government doesn't deliver, markets may witness a pullback. High crude prices may also be a drag on Indian equities. Coal and power are well known risks," Saurabh Mukherjee, head of equities at Ambit Capital told NDTV Profit.
(With inputs from Reuters)