NEW DELHI (Reuters) - India's economy grew at 8.6 percent in the first quarter - its fastest in six months - thanks to government and consumer spending, which was roughly in line with expectations and likely to keep the central bank on its path of gradual monetary tightening.

While worries over Europe's debt crisis had dampened expectation that the Reserve Bank of India would raise interest rates before its next scheduled policy review on July 27, when most analysts expect another rate rise, yesterday's report adds to the case for tightening, an HSBC economist wrote.

"Investment and manufacturing have powered the expansion so far, with consumption and services still lagging the advance. The details suggest that growth could be stronger still in the coming quarters, lending yet more urgency to rate hikes by the RBI," wrote Frederic Neumann, regional economist at HSBC in Hong Kong.

The rupee trimmed losses after the data but gave up those gains in line with the choppy stock market.

Dealers said hopes that the eurozone crisis may slow the process of rate hikes had abated yesterday's data release.

Meanwhile, the monsoon rains that are vital for farm output in India hit the country's southern coast as forecast, the weather office said yesterday, welcome economic news after last summer's drought, which drove up food prices.

"This release is a backward-looking number and our sense is that policymakers would remain considerate of the external developments and any associated downside risk to overall growth," said Anubhuti Sahay, a Standard Chartered economist in Mumbai.

Sahay expects the Reserve Bank of India to raise rates by 25 bps in the July policy review. The RBI has already lifted rates twice by a total of 50 basis points since mid-March.

Morgan Stanley economist Chetan Ahya lowered his expectation for an increase in the key repo policy rate in the second half of 2010 to 50 basis points from an earlier 75 basis points, citing debt concerns in Europe and a slowdown in inflows. He maintained his outlook for a further 100 basis points of tightening in 2011.

RBI Deputy Governor Subir Gokarn said the central bank would "steadily" normalise its policy rates, in an interview to the Indian Express newspaper that was published on Monday.

The 8.6 percent expansion in the fourth quarter of the fiscal year 2009/10 was broadly in line with a median forecast of 8.7 percent in a Reuters poll and lifted the annual growth rate for the full fiscal year to a slightly better-than-expected 7.4 percent.

India's economy grew 6.7 percent in 2008/09, and the Jan-March 2009/10 growth rate matches the revised data for the second quarter of 2009/10.

Manufacturing output grew 16.3 percent year-on-year in the quarter as consumers bought more cars and other goods, while farm output grew an annual 0.7 percent, thanks to a good winter harvest.

The government expects the economy to grow 8.5 percent in the current fiscal year that started on April 1 on the prospects of a better farm output and a global recovery. Finance Minister Pranab Mukherjee yesterday said growth would exceed that estimate.