Nov. 6 (Bloomberg) -- Australia’s central bank said the nation’s economy will expand at more than three times the pace forecast in August, and signaled it will continue to lead the world in raising interest rates.

“A further gradual lessening of monetary stimulus is likely to be required over time,” the Reserve Bank said in Sydney today. Gross domestic product will rise 1.75 percent this year and 3.25 percent in 2010, the bank said. Three months ago, it forecast gains of 0.5 percent and 2.25 percent respectively.

The currency gained, and is set for its biggest weekly gain in a month, as the report reinforced economists’ expectations of a another quarter-point interest-rate increase next month. Governor Glenn Stevens this week became the first central banker to raise rates twice this year, citing a rebound in consumer confidence and Chinese demand for exports.

The bank’s optimism “will continue to keep upward pressure on interest rates over the medium term,” said Shane Lee, an economist at Australia & New Zealand Banking Group Ltd. in Melbourne. “The importance of Asia, particularly China, was highlighted in today’s statement.”

The Australian dollar traded at 91.47 U.S. cents at 6:41 p.m. in Sydney from 91.01 cents before the statement was released. The two-year government bond yield was unchanged at 4.67 percent. A basis point is 0.01 percentage point.

‘Extended Prosperity’

Reserve Bank Deputy Governor Ric Battellino told a conference in Perth today that Australia faces an “extended period of prosperity in the years ahead,” driven by foreign investment in mining, that will put strain on the country’s housing and labor markets.

“Workers are likely to be in short supply, leading to strong demand for skilled migrants and therefore fast population growth,” Battellino said. “This, in turn, will have flow-on effects for housing markets.”

The economy will continue its expansion in 2011 and 2012 as companies boost investment in resources, including Western Australia’s A$43 billion ($39 billion) Gorgon liquefied natural gas project owned by Chevron Corp., Exxon Mobil Corp. and Royal Dutch Shell Plc, the bank said in today’s quarterly monetary policy statement.

“Growth in business investment and exports is expected to be strong, underpinned by the ongoing expansion of the resources sector,” the bank said. “The outlook for Australia’s terms of trade has also improved, with some increase now expected over the next year or two.”

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BHP Billiton Ltd. and Rio Tinto Group boosted iron ore production to a record in the third quarter to satisfy rebounding Chinese demand for steel, which helped exports surge 5 percent in September.

The Reserve Bank’s outlook is stronger than other nations. Japan’s central bank has forecast its economy will shrink 3.2 percent this fiscal year and expand 1.2 percent next year. The European Commission forecasts the region’s economy will expand 0.7 percent next year. The U.S. economy grew at an annual 3.5 percent pace in the third quarter after a yearlong contraction.

Stevens and his board raised the overnight cash rate target by a quarter percentage point in October and this week to 3.5 percent, and signaled further “gradual” increases.

“They’ve substantially upgraded their forecast for growth, which is pretty consistent with what Stevens has been saying recently about growth accelerating to trend,” said Ben Dinte, an economist at Macquarie Group Ltd. in Sydney.

“They’re also saying the lessening of monetary policy stimulus should be a gradual process,” Dinte added. “They’ll stay on hold in December before raising again in February and April.”

Cash Handouts

The economy is growing faster and generating more jobs than the government and central bank forecast earlier this year, helped by Prime Minister Kevin Rudd’s decision to distribute A$20 billion in cash to households, which has boosted retail sales. He is also spending another A$22 billion updating roads, railways and schools.

Myer Holdings Ltd. and David Jones Ltd., the nation’s largest department-store chains, this week reported first- quarter sales rose as the improving economy enticed consumers to spend more on clothing and cosmetics.

Core inflation is forecast to slow to 2.25 percent in 2010 from 3.25 percent in 2009, the bank said. Policy makers aim to keep inflation between 2 percent and 3 percent on average.

The headline consumer price index, which includes more volatile prices such as gasoline, will hold within that target range through to the June quarter of 2012.

Parity Bets

Slower wages growth and falling costs for imported goods because of the recent gain in the Australian dollar “suggest that a further moderation in underlying inflation is likely over the period ahead,” today’s report said.

Speculation that Stevens will continue raising borrowing costs, as counterparts in the U.S., Europe and the U.K. keep their own benchmark rates at historic lows, has pushed Australia’s currency toward parity with the U.S. dollar.

Australia’s currency will trade for 1 U.S. dollar next year, according to forecasters at Citigroup Inc., Calyon, Barclays Capital and National Australia Bank Ltd., implying an additional 10 percent gain. Hedge funds and other large traders last month had more bets than at any time since July 15, 2008, that the rally will continue, data from the Washington-based Commodity Futures Trading Commission show.

Faster Growth

Investors are betting there is a 64 percent chance policy makers will increase the key rate by another quarter point on Dec. 1, according to Bloomberg calculations based on interbank futures on the Sydney Futures Exchange at 5:13 p.m. That would be the first time in history the bank has raised borrowing costs at three successive meetings.

GDP will expand 3.25 percent in 2011 and 3.5 percent in the year through June 30, 2012, according to today’s forecasts, which the bank said it prepared using the assumption that the benchmark lending rate “increases gradually.”

“Conditions in the global and Australian economies are significantly better than was expected when the board lowered the cash rate to 3 percent,” a half-century low, in April, today’s statement said.

“The Australian economy is operating with less spare capacity than earlier thought likely, and the outlook for the next few years has improved,” the bank added.

While employment growth is expected “to be subdued” over the next couple of quarters, before accelerating in 2010, the outlook for the labor market has “improved” since the bank’s August policy statement.

The bank didn’t provide specific forecasts for the jobless rate, which unexpectedly fell in September for the first time in five months, declining to 5.7 percent from 5.8 percent.

To contact the reporters for this story: Jacob Greber in Sydney at jgreber@bloomberg.netJason Scott in Perth at jscott14@bloomberg.net

Last Updated: November 6, 2009 02:49 EST