The S&P BSE Sensex rebounded by 171 points on Tuesday following a larger-than-expected rate cut announced by the Reserve Bank of India (RBI).

The Sensex closed at 25,822 points while the 50-share Nifty rose by 34 points, or 0.43%, to end at 7,845 points. In the late afternoon session, the Sensex surged by over 400 points to break above the 26,000 level but could not sustain the gains due to weakness in global markets.

The RBI surprised the markets by cutting the repo rate by 50bps (basis points) on Tuesday. Markets had expected the central bank to reduce the rate by 25bps.

With the latest cut, the RBI has slashed the repo rate by 125bps to 6.75% so far this year. The central bank, however, kept the cash reserve ratio (CRR) unchanged at 4%.

"The Reserve Bank of India's (RBI's) decision to cut the repo rate by 50bp today, to 6.75%, went beyond what most had expected. But having stated that its attention will now turn to its medium-term inflation target, we think that there is little scope for the RBI to loosen policy further," said Capital Economics in a note.

However, the central bank revised down its forecast for India's gross domestic product (GDP) growth to 7.4% for the fiscal year 2015-16.

Given the downtrend in inflation rates, the prospect for further easing by the RBI remains. The retail inflation fell to a record low of 3.66% in August, while the wholesale price index (WPI) remained in negative teritory for the tenth straight month.

"In our view, even with some hike the US Federal Reserve rates likely later this year, there is head room for the RBI to remain accommodative as structural factors driving inflation in India have abated and global deflationary forces remain strong," said Dinesh Thakkar, CMD of Angel Broking.

Stocks of interest rate-sensitive sectors such as banking, real estate and autos went up sharply following the RBI's rate cut decision.

Among realty stocks, HDIL rose nearly 10% while DLF ended about 4% higher. While shares of private sector banks such Axis Bank and ICICI Bank ended in the red, the stock price of India's largest lender SBI closed nearly 1% up.

In the auto space, the share price of Maruti Suzuki soared over 3% to Rs 4,674, while Mahindra & Mahindra ended nearly 1.5% higher.