The wholesale price index, India's most widely watched inflation measure, rose 0.44 per cent in the 12 months to March 7, sharply lower than the previous week's 2.43 per cent and below a forecast of 0.89 per cent in a Reuters poll.

It was the lowest reading since annual numbers in the current series began in April 1995, well below the previous low of 1.13 per cent on Feb. 2, 2002, and a peak of 12.91 per cent last August.

"We are looking at deflation by the last week of March. It will have a stabilising impact on bond yields in the days to come," said Abheek Barua, the chief economist at HDFC Bank.

"It also gives the central bank that much more headroom to keep cutting rates."

The new benchmark 10-year bond fell to 6.39 per cent from 6.44 per cent before the data, but later unwound the fall.

Since October, the central bank has cut its key lending rate by 400 basis points, most recently in early March, as the policy focus has shifted to boosting demand and arrest slowing growth.

Trade secretary G.K. Pillai said inflation would not be a concern for the next 2-3 months, but some analysts say policy makers would be in a dilemma over further rate cuts as the consumer price index is still over 9 per cent in annual terms.

HDFC's Barua said a sharp decline in food prices would help close the gap between the wholesale and consumer price indexes.

Cuts in state-set fuel prices, falling global commodity prices, and policy measures such as cuts in duties and interest rates have contributed to the sharp fall in wholesale price inflation over the past seven months.