The benchmark 10-year bond yield ended down 10 basis points at 6.66 percent, its lowest since April 6, while the five-year benchmark overnight indexed swap ended at 6.37 percent, compared with its previous close of 6.49 percent.

The broader NSE share index rose 0.3 percent, while the rupee strengthened to 64.3250/3350 from Tuesday's close of 64.4250.

The less hawkish tone at the policy sent the Nifty bank index up as much as 0.8 percent to a record high.

The rally in bonds came after the Reserve Bank of India lowered its inflation projections and delivered a slightly less hawkish policy statement than its last one on April, while keeping the repo policy rate unchanged as widely expected.

The statement was seen opening the door for a potential rate cut, although the RBI said it wanted to see more evidence of easing inflation.

"We expect the RBI to cut rates in its next policy meeting in August, provided the monsoon progresses well, in line with Meteorological Department's forecasts, and inflation does not spike after goods and services tax rollout," said Sudhakar Pattabiraman, head of research operations at William O'Neil India.

Signs are pointing to benign inflation: weather forecasters are predicting a normal monsoon, and other positive factors include falling commodity prices, and a 5 percent rally in the rupee that has made imports cheaper.

At the same time, the RBI acknowledged the economy was growing more slowly than expected, spurring the central bank to try to boost credit growth by lowering its statutory liquidity ratio (SLR) - the amount of bonds banks must set aside - by 50 basis points to 20 percent of total deposits from June 24.