* RBA raises cash rate 25 bps to 3.5 pct as expected
* Repeats that it's prudent to gradually lessen stimulus
* Market pares chance of another rise as soon as December
By Wayne Cole
SYDNEY, Nov 3 (Reuters) - Australia's central bank raised interest rates for a second straight month on Tuesday as it steadily withdrew stimulus from an improving economy, but was careful not to fuel expectations for another hike in December.
The Australian dollar dipped and bill futures rallied as investors detected a hint of caution in the Reserve Bank of Australia's (RBA) words even as it lifted rates by 25 basis points to 3.5 percent.
"The statement suggested the RBA was open minded about skipping a hike in December, and then going in February," said Rory Robertson, interest rate strategist at Macquarie.
The RBA never holds a monthly policy meeting in January.
"They mentioned the strength of the exchange rates and used the key word 'gradually', which is taken to mean it will tighten in small steps but not necessarily at every meeting," he added.
The market had been fully priced for a rise to 3.75 percent next month, but after the announcement interbank futures climbed 0.110 points to 96.37, implying a rate of 3.63 percent. Doubts about a December hike undermined the local dollar, pulling it down over half a U.S. cent to $0.9015. "It's interesting that the Reserve Bank in its history has never lifted interest rates for three consecutive meetings," noted Craig James, chief equities economist at CommSec.
"We believe they will hold fire in December, and come back in February after they have had time to assess the impact of the rate hikes on the economy," he said.
(For a graph of rates click on:
http://graphics.thomsonreuters.com/119/AU_CBRTS1109.gif)
OUTPERFORMING
The central bank's October rise had made it the first in the G20 to tighten since the global credit crisis blew up and this latest move could add to pressure for action elsewhere.
Central banks in the United States, euro zone and Britain all meet this week but none is considered remotely close to lifting rates.
Australia was almost alone among developed economies in dodging recession, thanks in part to aggressive stimulus, a sound banking system and Chinese demand for its commodity exports.
That relative outperformance was highlighted by the Labor government's mid-year financial review out this week where it sharply revised up its forecasts for economic growth while cutting the likely peak for unemployment.
That optimism was echoed by the central bank in the statement following Tuesday's policy meeting, saying growth was likely to return to trend next year and unemployment would peak at a "considerably lower level" than previously thought.
With the economy performing surprisingly well, the RBA believes there is no need for rates to be at 50-year lows and that keeping them down could over-stimulate some sectors.
Policy makers have been particularly anxious to avoid inflating the sort of bubble in housing prices that wreaked so much damage on the U.S. economy.
Figures out Monday showed national house prices jumped 4.2 percent in the third quarter to a record high, surpassing the previous peak from early 2008.
That's one reason some analysts still expect a steady drum oll of hikes from here on.
"We're getting mixed signals on the speed of when they're going...but if the economy continues as it is you'd have to think that we'll be lining up this time next month for another go," said Michael Blythe, chief economist at Commonwealth Bank.
Interbank futures still imply rates of 4.75 percent by June next year, while a measure from Credit Suisse based on swap rates shows no less than 189 basis points of tightening priced in for the next 12 months.
That would lift the cash rate above 5 percent and back to levels that analysts consider neutral for the economy -- neither retarding nor stimulating growth. (Editing by Mark Bendeich and Tomasz Janowski)