The New Zealander started the day two shots from the lead after opening with a three-under-par 70.
But by the midway point of her second round on Friday she had picked up a further three shots to move to six under, a stroke clear of overnight leader Ilhee Lee and fellow Korean Ha Na Jang.
After starting her second round on the back nine on Friday morning, the 17-year-old Ko carded an eagle, three birdies, two bogeys and just three pars in her opening nine holes.
The highlight was the eagle on the 350m par-four 15th hole, when she holed out with a nine-iron from 125 metres.
Jang also made a fast start on a hot, still morning at Royal Melbourne, picking up three shots in her first 11 holes to move to five under.
Lee, the world No.59, was due to begin her second round at 1250 (AEDT).
Katherine Kirk and Rebecca Artis were the leading Australians, having started the tournament with one-under 72s on Thursday.
Countrywoman Karrie Webb began her title defence with a solid level-par 73 and was to begin her second round at 1250.
