OTTAWA (Reuters) - The Bank of Canada may raise interest rates in the short term to tame higher-than-expected inflation, the central bank said on Tuesday, after holding its key overnight rate steady at 4.25 percent.

The clear tightening bias was a marked departure from the central bank's neutral preference since May 2006, in the longest period of rate stability since the early 1970s. The hawkish statement triggered an immediate rise in the Canadian dollar to a 29-1/2 year high at C$1.0746 to the U.S. dollar, or or 93.06 U.S. cents.

"On balance, the bank judges that there is an increased risk that future inflation will persist above the 2 percent inflation target and some increase in the target for the overnight rate may be required in the near term to bring inflation back to target," it said in a statement.

Twelve of Canada's 13 primary securities dealers had predicted no rate move on Tuesday, in a Reuters survey last week. One did not provide forecasts. But seven of the 12 dealers saw a rate hike by the end of the year, up from just two in a previous survey in April. Only one, Toronto-Dominion Bank, called for a rate hike at the bank's next decision date on July 10.

The bank said that both total inflation and core inflation, which strips out volatile items, came in higher than expected in April.

"The bank now judges that there is somewhat greater excess demand in the economy than was thought to be the case in April," it said.

It also said first-quarter growth was likely to be 3.5 percent, a full percentage point higher than its estimate in a Monetary Policy Report last month. Gross domestic product growth slipped last year from 3.8 percent at the start of the year to 1.4 percent in the fourth quarter. The bank and economists had expected growth to pick up this year but not quite as much as it did.

Likewise, the Canadian dollar has traded significantly above the range assumed by the bank.

Strong growth outside North America has translated into strong demand for Canadian commodities, the bank said in an apparent signal that the currency's gains were not speculative and would therefore not stand in the way of a rate hike.