MUMBAI (Reuters) - Morgan Stanley raised its forecast for India's economic growth to 8.5 percent in 2010/11 from 8 percent earlier, citing a pick-up in domestic consumption and said interest rates would climb as inflation accelerates.

"The key driver for this higher growth will be domestic demand, particularly investments," the investment bank said in a research note on Thursday.

The stronger growth will be followed by higher inflation and policy rates, it said.

It forecast the reverse repo rate, the central bank's main short-term borrowing rate, to rise by 175 basis points in calendar 2010 from its earlier projection of 150 basis points increase. The reverse repo is currently at 3.25 percent.

Last week, the Indian central bank kept key rates unchanged but raised banks' cash reserve requirement, signalling it aimed to rein in the loose monetary policy that was put in place to head off the impact from the global slowdown.

Morgan Stanley also revised its gross domestic product growth forecast for 2009/10 to 7.1 percent from 6.7 percent earlier.

The Reserve Bank of India had last week raised its 2009/10 GDP projection to 7.5 percent from 6 percent earlier.

The U.S. investment bank has raised its non-food inflation expectation to an average 5.5 percent in 2010/11 from 4.5 percent earlier on build-up of domestic demand pressures.

It projected the Indian economy to grow 8.4 percent in 2011/12 from its previous projection of 7.6 percent.

(Reporting by Suvashree Dey Choudhury; Editing by Ranjit Gangadharan)

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