MUMBAI (Reuters) - The Reserve Bank of India raised a key short-term interest rate on Tuesday to ward off price pressures, as expected, and increased its growth forecast for one of the world's fastest expanding economies.

The central bank lifted its reverse repo rate, used to drain liquidity from the money market, by a quarter of a percentage point to 5.25 percent, prompting stocks and the rupee to firm and benchmark bond yields to rise.

"Underlying growth momentum remains strong and we expect demand-driven inflationary pressures will rise," said Rajeev Malik, an economist at JP Morgan in Singapore. "We continue to expect another reverse repo hike in January."

The Reserve Bank of India (RBI) said it expected Asia's third-largest economy to grow 7.0-7.5 percent in the fiscal year to the end of next March, having forecast in April that growth would be around 7.0 percent.

It based its latest forecast on a pick-up in farm output, which generates a fifth of gross domestic product, and momentum in industry and services.

Tuesday's widely expected rate rise takes the reverse repo to its highest in 2-1/2 years. It last raised the rate -- by a quarter of a percentage point -- in April.

The central bank surprised analysts by raising the repo rate, used to add liquidity to the money market, by a quarter of a percentage point to 6.25 percent, while leaving the bank rate for pricing long-term loans steady at 6.0 percent.

But the central bank suggested further inflationary pressures were in the pipeline, warning markets that higher international crude prices had only been partially passed through into domestic prices and second-round effects were not yet "noticeably significant".

"It is necessary to be in readiness to take further measures as warranted to meet the challenges posed by the evolving situation," the RBI said.

The rupee slipped to 45.13 per dollar after the rates decision from 45.1150 beforehand, but later rebounded to 45.0950. The yield on the active 9-year bond edged up to 7.0143 percent from 6.9971 percent.

The central bank has projected wholesale price inflation of 5.0-5.5 percent at the end of the current fiscal year, but RBI governor Yaga Venugopal Reddy said on Tuesday it had an informal inflation ceiling below that level.

"The policy response that has been indicated... is exactly meant to contain inflation within 5.0-5.5 percent and to have a medium-term situation where ... I would like to treat an informal mandatory ceiling for inflation of less than 5," he told a news conference.

The RBI said crude prices were still the most critical factor affecting the domestic inflation outlook, adding inflation expectations had to be contained.

The RBI said rapid credit growth and the potential for bad debts, needed careful monitoring. Commodity price inflation was low, but asset prices, especially house prices, had increased substantially, it said.

Domestic factors continued to prevail over global factors in determining policy, but the central bank said the $700 billion Indian economy was increasingly linked to the world economy.

Soaring oil import costs have fuelled imports, widening the current account and trade deficits. Analysts expect the accumulated trade gap to reach a record $48 billion by the end of the fiscal year.

The central bank said rising international competitiveness of India's invisible exports and remittances from Indians working abroad, as well as capital inflows, had ensured the current account deficit was "manageable".

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