Weak global trends following poor economic data in the US and China also impacted the market sentiment.
The 30-share index closed at 21,133.56 points, down by 240.10, or 1.12 per cent -- the biggest loss since January 2. The barometer had closed at record high levels in the previous two sessions on the back of strong corporate earnings.
Profit booking was triggered by RBI Governor Raghuram Rajan comments that inflation was a "destructive disease" that was forcing the bank to keep interest rates high, brokers said. "The point is inflation is hitting the growth in the long run. There can be no trade-off. There is need to bring inflation down," Rajan had said yesterday.
The broad-based National Stock Exchange index Nifty fell by 78.90 points, or 1.24 per cent, to settle at 6,266.75.
"Markets did react to the weak economic data in China and US," said Dipen Shah, Head- Private Client Group Research, Kotak Securities.
Interest rate sensitive stocks suffered the most, with the BSE realty index dropping the most by 3.19 per cent. Capital Goods index fell by 2.68 per cent, Consumer Durables index by 2.65 per cent and banking index by 1.88 per cent.
Trading sentiment also dampened as drugmaker Ranbaxy Laboratories Ltd
tumbled by 19.33 per cent after the US regulators banned it from producing or selling drug ingredients for the American market from a fourth plant in India.
BSE Sensex retreats from record high, drops 240 pts
(Reuters) BSE Sensex provisionally closed over 1 per cent lower, retreating from a record closing high hit in the prior session as interest-rate sensitive stocks declined after the central bank governor issued a strong warning on inflation.
The benchmark BSE index provisionally closed 1.09 per cent lower at 21,141.06, while the broader NSE Nifty closed 1.21 percent lower at 6,266.75.
Ranbaxy Laboratories Ltd, majority owned by Japan's Daiichi Sankyo Co Ltd, plunged 19.54 per cent to Rs 335.65 at the close on the BSE after the U.S. Food and Drug Administration banned more products from the Indian drugmaker.