Australia's central bank unexpectedly raised interest rates by a quarter point Tuesday, becoming the first major economy to increase the cost of borrowing amid signs its recovery from the global slump is gaining momentum.

The Reserve Bank of Australia raised its cash rate to 3.25 per cent from a 49-year low of three per cent. Between September 2008 and April this year, the rate was slashed a total of four and a quarter percentage points as the financial crisis morphed into a global recession.

The rate hike, which comes after recent data showed the economy was improving, sent the Australian dollar soaring to a 14-month high against the U.S. dollar.

'Prudent' to begin reducing stimulus

The central bank's governor, Glenn Stevens, said it was "prudent" to begin gradually reducing the stimulus provided by low interest rates. He said the risk of "serious economic contraction" in Australia had passed.

At a Group of 20 summit in the U.S. last month, leaders of major developing and industrialized nations agreed to keep their stimulus efforts — which include increased government spending and low interest rates — largely in place for now to avoid derailing still-fragile recoveries.

But Australia, a G-20 member, has weathered the worst global downturn in decades better than other developed countries. It avoided slipping into recession — helped by stable banks, demand from China for iron ore and other minerals, and the government's $37 billion Cdn of stimulus spending.

Asia, a crucial market for Australia's mineral exports, is rebounding from the downturn faster than the West and could face asset bubbles and a spike in inflation if governments wait too long to withdraw stimulus measures. Rising food prices are already becoming a problem in India. HSBC economists said in a report Tuesday that South Korea, Indonesia and the Philippines are also on the radar as countries particularly vulnerable to an inflation blowout.

Australia's economy grows

Australia's gross domestic product grew 0.6 per cent in the second quarter, accelerating from 0.4 per cent growth in the previous quarter. In September, consumer confidence surged to its highest level since July 2007. Since March, Australian shares are up 50 per cent.

Stevens said the global economy was growing and its recovery was likely to continue during 2010. The prospects for Australia's Asian trading partners appeared to be "noticeably better," he said.

"Growth in China has been very strong, which is having a significant impact on other economies in the region and on commodity markets," Stevens said.