The BSE Sensex traded with strong gains despite headline inflation rising at higher than estimated 7.55 per cent in August. The rise in inflation dims hopes of a rate cut next week, when the Reserve Bank meets to review the monetary policy.
"We are not looking at any rate action from the RBI on the 17th of September in view of the rise in manufactured goods inflation," Indranil Pan, chief economist at Kotak Mahindra Bank said.
At 11.50 a.m., the Sensex traded 376 points or 2.1 per cent higher at 18,397 while the broader Nifty advanced 117 points to 5,552.
Earlier, the Sensex jumped over 400 points on the back of a global rally. The US Federal Reserve's decision to launch a third round of quantitative easing sent stocks soaring worldwide. Indian markets are trading at the highest level since February 2012.
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 coming back on tracks. Investors have been concerned over the rising subsidy bill because state-run oil refiners have been selling fuel at below market prices.
The government hopes the move will help avert a sovereign credit downgrade, the prime minister's chief economic advisor, C. Rangarajan, said. "The government has shown it can take hard decisions, very difficult decisions."
The cabinet's economic panel is due to meet on Friday 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.
"This is more than what we can handle right now. Domestic cues have come last evening. I just hope the government sticks to the fuel price hike. The government may allow FDI in aviation today evening. That will keep the markets running up," market analyst Ambareesh Baliga said.
Banking and metal stocks led the gains on the BSE, rising nearly 3.5 per cent each. Barring defensive stocks, such as healthcare, FMCG and consumer durables, all other groups of stocks traded with strong gains.
47 of the 50 stocks traded higher on the Nifty. Aluminium maker Hindalco was the top Nifty gainer, up nearly 7 per cent. Infra and cement major Jaiprakash Associates, India's biggest realty firm DLF, and private steel maker JSPL traded with 5-6 per cent gains.
Private lender ICICI Bank and India's biggest lender SBI traded 4-4.5 per cent higher. Shares in state-run refiners - BPCL, IOC and HPCL - traded off the day's high amid profit booking.
The market breadth was strong with over 80 per cent stocks rising on the broader BSE 500.
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.
US markets staged a huge rally Thursday after investors got the aggressive economic help they wanted from the Federal Reserve. The Dow Jones industrial average spiked more than 200 points and cleared 13,500 for the first time since the beginning of the Great Recession. The average is within 625 points of its all-time high.
Asian shares rose to a four-month high on Friday after the U.S. Federal Reserve announced an aggressive new stimulus to drive job creation in the U.S. economy.
The Fed's move will likely accelerate the risk-positive momentum at work since the European Central Bank's bond-buying scheme to get borrowing costs down for euro zone members was approved by Germany's constitutional court.
Japan's Nikkei stock average opened up 1.1 percent.
(With inputs from agencies)