* India central bank raises interest rates by 25 bps each
* Sees balance of risk tilted towards inflation
* Bank lifts March 2011 inflation projection to 7 pct
* Bond yields, swap rates ease after rate rise (Adds details, comments, background)
By Suvashree Dey Choudhury and Tony Munroe
MUMBAI, Jan 25 (Reuters) - India's central bank raised interest rates on Tuesday by 25 basis points, as expected, to clamp down on resurgent inflation, warning higher food prices could become entrenched if steps to boost output are not taken.
Even though the Reserve Bank of India has raised its policy rates seven times since March, it said that the balance of risks had tilted towards stronger inflation and it stood ready to respond if price pressures increased.
The comments backed market views that the central bank would need to raise rates again in coming months. Indeed, bond yields and swap rates eased after the central bank decision because some investors had expected a 50 basis point rate rise.
"India has a serious inflation problem, something officials have been highlighting recently. I suspect the market would have been looking for a bolder move in terms of a 50 basis points move," said Jonathan Cavenagh, senior FX strategist at Westpac Institutional Bank in Singapore.
"They need to show the market that they are prepared to get ahead of the curve but a 50 basis points move may have prompted fears of a pullback in growth," he said.
The RBI raised its repo rate , at which it lends to banks, to 6.5 percent from 6.25 percent and it lifted its reverse repo rate , at which it borrows from banks, to 5.5 percent from 5.25 percent.
Economists in a Reuters poll had forecast the central bank would raise the rates by a quarter point on Tuesday and by 75 basis points during 2011.
The central bank is trying to balance the need to prevent food prices, which the United Nations food agency says are at a record high globally, from spreading to broader inflation while keeping economic growth near 9 percent.
Several government ministers have made it clear they are not in favour of aggressive tightening of monetary policy, fearful than any impact on growth could hit their political support ahead of a series of state elections that, if lost, could damage the ruling coalition.
"As high food inflation persists, the prospect of it spilling over to the general inflation process is rapidly becoming a reality," Reserve Bank of India (RBI) Governor Duvvuri Subbarao said in the policy document.
"The balance of risk has tilted towards intensification of inflation," he said.
BALANCING ACT
The yield on the most traded 8.13 bond maturing in 2022 eased to 8.17 percent after the announcement before rebounding to 8.25 percent, a level it had held on to before the review.
The 1-year OIS rate eased to 7.36 percent from 7.42 percent before the central bank announcement. The benchmark five-year swap fell to 7.98 percent from 8.03 percent.
"The RBI is trying to stem inflationary pressure, but at the same time is being cautious that growth is not impacted. They are following a gradual approach for rate hikes, so that pressure is not felt suddenly," said Deven Choksey, managing director at K R Choksey Shares & Securities in Mumbai.
"The market is relieved, and seems to be taking a positive view of this approach."
India's ruling Congress party is under pressure over rising prices for food and fuel, as well as its handling of corruption scandals.
But, fearful of losing support among farmers and small traders, it has balked at reforms to increase food supply and productivity, such as allowing foreign investment in supermarkets.
Food inflation has been in double digits for more than a year, even before the current global pressures, and onion prices, a key part of Indian food, have risen around 70 percent over the last year.
The central bank joined a growing chorus for reforms to agriculture.
"Unless meaningful output enhancing measures are taken, the risks of food inflation becoming entrenched loom large and threaten both the sustainability of the current growth momentum and the realisation of its benefits by a large number of households," Subbarao said.
The wholesale price index , the most widely watched inflation gauge in India, rose 8.43 percent in December from a year earlier, compared with 7.48 percent in November.
The RBI on Tuesday lifted its headline inflation projection for March 2011 to 7 percent from 5.5 percent previously, and said it expected inflation to begin moderating again in the first quarter of the fiscal year that starts in April.
The RBI's perceived comfort zone for inflation is 5-6 percent in the short term and 3-4 percent in the medium term.
The central bank stuck with its 8.5 percent economic growth forecast for the current fiscal year, but with an upside bias. (Writing by Alistair Scrutton; Additional reporting by Neha D'silva; Editing by Neil Fullick)