* Fighting inflation takes precedence over short-term growth- cbank
* Repo rate raised 50 bps to 7.25 pct, reverse repo to 6.25 pct
* Inflation to remain near 9 pct in first half of FY12- cbank
* Risk of inflationary expectations becoming "unhinged"
* Bond yields, swap rates rise sharply, stocks fall (Adds snap poll result, updates markets)
By Tony Munroe and Suvashree Dey Choudhury
MUMBAI, May 3 (Reuters) - India's central bank stepped up its fight against stubbornly high inflation on Tuesday, raising interest rates by a bigger-than-expected 50 basis points and vowing to battle price pressures even at the cost of some economic growth.
The rate rise exceeded forecasts for a 25 basis point rise, although the case for stronger action had been building since data showed March inflation reached nearly 9 percent. It also cast doubt on the government's ambitious growth targets.
The Reserve Bank of India has been among the most aggressive central banks anywhere with nine rate rises since March 2010 but its gradual policy tightening has failed to cool inflation initially driven by high food and fuel prices, and more recently by demand pressures.
"Current elevated rates of inflation pose significant risks to future growth," RBI Governor Duvvuri Subbarao said in the bank's annual monetary policy statement. "Bringing them down, therefore, even at the cost of some growth in the short-run, should take precedence."
The RBI lifted its repo rate , at which it lends to banks, to 7.25 percent from 6.75 percent. The reverse repo rate was increased by a similar amount to 6.25 percent.
It warned that wholesale inflation, the main measure of price pressures in Asia's third-biggest economy, would remain around March levels in the first half of the fiscal year that began in April, before easing.
It set an inflation target of 6 percent, with an upward bias, for the end of the fiscal year.
The inflation warning and tough language prompted economists to raise their forecasts for interest rates this year.
A snap Reuters poll showed they now expect India's repo rate to reach 8 percent by the end of 2011, a full percentage point higher than expectations in a poll in January. [ID:nL3E7G31UO]
The 1-year overnight indexed swap rate jumped as much as 20 basis points and the 5-year rate rose 11 basis points, flattening the curve after the central bank meeting. The 10-year benchmark bond yield rose as much as 8 basis points.
Indian shares tumbled 2.44 percent, and banking shares dropped more than 3 percent as investors factored in a hit to earnings from higher credit costs.
The central bank's decisive action and comments restore some of the inflation-fighting credibility it lost while sticking with a "calibrated" approach to tightening in the face of the government's pro-growth bias, which some analysts said had underplayed inflation risks.
"The RBI is talking more realistically about the inflation trajectory and responding a little more aggressively," said Abheek Barua, chief economist at HDFC Bank in New Delhi.
"It is a more adequate action than in the past. In the long term, it will help to curb inflation, but not immediately. We are expecting another 75 basis points hike in 2011," he said.
Central banks in other developing markets have also been raising rates as their economies emerged from the global financial crisis much faster than industrialised countries. Data showing slowing manufacturing growth in China indicates that a series of policy measures by Beijing is having an effect.[ID:nL3E7G100E]
"UNHINGED"
Much of India's stubbornly high inflation is blamed on supply bottlenecks, including in food output, which are beyond the scope of monetary policy.
However price pressures have become more widespread prompting the central bank to take more decisive action to prevent the price pressures seeping deeper into the economy.
"Inflation has consistently surprised on the upside and there is little choice but for the central bank to send a strong tightening signal/anti-inflation stance as they have done," said Ramya Suryanarayanan, economist at DBS Bank in Singapore.
Suryanarayanan predicted a further 50 basis points of tightening by July.
Food price inflation of more than 9 percent and double-digit fuel price growth have added pressure on a Congress party-led government already reeling from a spate of corruption scandals.
Slower economic growth would be another political headache for Prime Minister Manmohan Singh.
His government counts on growth of 9 percent for the current fiscal year to help fund increased social spending and keep the fiscal deficit in check.
The target is in excess of most private forecasts and the central bank's expectation for growth of about 8 percent, which assumes a normal summer monsoon and global crude oil prices of $110 a barrel.
The economy grew by an estimated 8.6 percent in the year that ended in March 2011.
With inflation high despite a flurry of rate rises, the central bank also said it would make the repo rate its main policy tool, a move analysts said was designed to ensure rate changes had a more direct impact on the economy.
The repo rate will now be the only independent rate, unlike previously when the central bank could change the repo rate or the reverse repo rate, or both. [ID:nL3E7G317O]
Subbarao said India needed to maintain price stability if medium-term growth was to be sustained.
"Persistently high rates of inflation raise the risks of inflationary expectations becoming unhinged," he said.
Earlier in the day, Australia's central bank held interest rates steady at 4.75 percent on Tuesday but warned that underlying inflation could head higher, reinforcing the case for a further tightening in the coming months. [ID:nL3E7G3041] (Additional reporting by Swati Bhat and Neha D'Silva; Editing by Tomasz Janowski)