Maruti Suzuki, Tata Motors and Hindalco shares led the rally on sustained capital inflows, said dealers.
The decision to hike diesel, petrol and non-subsidised LPG prices was interpreted by investors as the government's resolve to take tough decisions, they added.
The 30-share Sensex resumed the day strong and soared further to finish at two-week high of 25,516.35, a rise of 102.57 points, or 0.40 per cent. It touched the day's high of 25,571.90. This was its strongest closing since June 17.
The gauge gained over 351 points in the previous two sessions.
The NSE 50-share Nifty moved up 23.35 points, or 0.31 per cent, to end at 7,634.70 after rising to 7,649.50.
"Manufacturing activity has stabilised and a gradual improvement is underway. This is also corroborated by the pickup in auto sales," said foreign brokerage Nomura.
Investors were in a cheerful mood after an HSBC survey today showed that India's manufacturing sector growth in June expanded at the fastest pace since February, supported by growing order flows, especially from overseas.
Stocks of country's largest car-maker Maruti Suzuki climbed 6.01 per cent to close at fresh record high of Rs 2,584.85 on strong sales growth in June. Mahindra & Mahindra, another automaker major, surged 4.03 per cent after company reported a marginal increase in total sales in June.
Hindalco Industries also caught buyers' fancy following reports of a rating agency upgrading the stock. It ended 6.76 per cent higher. It peer in the metal pack, Tata Steel gained 2.47 per cent.
Meanwhile, Foreign Portfolio Investors (FPIs) bought shares worth a net Rs 1,288.16 crore yesterday, as per provisional data from the stock exchanges.
Among BSE sectoral indices, auto index flared up by 3.24 per cent, followed by Metal that rose 2.03 per cent, Capital goods 1.27 per cent, Realty 1.03 per cent and Consumer Durables 0.98 per cent.