During a visit to Canberra by Myanmar's President Thein Sein -- the first leader from the former Burma to visit the Australian capital since 1974 -- Gillard said restrictions would be lifted on military humanitarian aid and peacekeeping, but an arms sales embargo would stay in place.
"What we've done today is taken a first step on defense relations between our two countries. It is not fully normalizing defense relationships," Gillard told reporters at a press conference with Thein Sein at Australia's parliament.
Since Myanmar's military stepped aside and a quasi-civilian government was installed in 2011, triggering a wave of political and economic reforms, western governments have cautiously dropped or eased sanctions against the country.
But the government still maintains a constitution drafted by the generals and reserves a quarter of parliamentary seats for military personnel, while barring Nobel laureate and opposition leader Aung San Suu Kyi from the presidency.
The United Nations Special Rapporteur on human rights in Myanmar last week warned that progress had been erratic in Myanmar, with around 250 political prisoners still behind bars and 120,000 people internally displaced.
Gillard said Australia, a rotating UN Security Council member and close U.S. ally, would soon post a defense attach to its embassy in Myanmar, and would also provide additional aid worth $20 million to train the government in human rights.
Thein Sein, a former junta general who has won praise for reforms since taking power in March 2011, said his government was looking to resource powerhouse Australia for investment and expertise in the country's fledgling resource sector.
"We have to make sure that the extraction and exploitation of these resources is done properly," he said.
Shut off from most of the world for decades, Myanmar is Asia's poorest country.
Gillard's government last year lifted targeted travel and financial sanctions on Myanmar outside military assistance, with aid set to double to $100 million a year by 2015.
(Reporting by Rob Taylor; Editing by Michael Perry)