The Indian benchmark 10-year bond yield slumped to a near five-month low on Tuesday after data showing headline retail inflation eased in February gave rise to expectations for a cut in the central bank's key policy rate next month.
The Reserve Bank of India is widely expected to cut repo rate by 25 basis points when it announces its policy statement on April 5.
Bonds were also lifted after the central bank said it will buy bonds up to 150 billion rupees ($2.23 billion) on Thursday through an open market operation (OMO), which is likely to take pressure off banks facing cash shortages due to corporate tax payouts.
Since January, the RBI has conducted bond buys through OMOs for 470 billion rupees and traders expect at least one more such bond purchase given the banking system liquidity deficit is around 1.5 trillion rupees.
"This rally is discounting the fact there could be one more OMO and a 25 bps rate cut on the policy day," said Vijay Sharma, senior executive vice-president at primary dealer PNB Gilts Ltd.
"I don't see space for too much further momentum, though any surprise (RBI rate move) could cause a further rally."
At 0447 GMT, the benchmark 10-year bond yield was down 3 basis points at 7.57 per cent, after earlier falling as much as 4 basis points to 7.56 per cent, the lowest since Oct. 19.
India's headline retail inflation, which the RBI closely tracks to set its interest rate policy, eased to 5.18 per cent in February from a year earlier, data showed on Monday.
"The recent spate of soft macro data and the general budget that reinforces fiscal consolidation has paved the way for imminent easing of 25 bps in policy rates," Citi said in a note on Tuesday.
The government has budgeted to reduce the fiscal deficit to 3.5 per cent of gross domestic product for 2016-17 fiscal year.
More immediately, the market will closely watch the outcome of the US Federal Reserve's two-day policy meeting, beginning on Tuesday.
The Fed is expected to stand pat on interest rates, and could also make clear that future hikes are on its agenda, despite concerns about global economic weakness, so long as US inflation and jobs continue to strengthen.