Finance minister Philip Hammond was at the airport to cheer the announcement by the Canadian-Kuwaiti consortium which owns the airport, a business travel hub located close to Britain's financial centre.
The "ambitious growth plans will boost international connections, strengthening the City of London's links to destinations across the world, and send a clear signal that Britain is open for business," he said.
The investment will expand the airport terminal, create more space for planes to taxi and add new stands to allow bigger planes to use the airport.
The finance ministry said it expected the expansion would create 1,600 airport jobs for staff, as well as 500 construction jobs and could contribute £1.5bn to the British economy by 2025.
Flights from City go to Europe as well as New York.
Last year it had a record 4.3mn passengers -- an 18% increase from 2014.
Its expansion had been blocked by then London mayor Boris Johnson, who is now the foreign minister.
But the new mayor Sadiq Khan lifted the ban.
The plan is being launched as proposals to expand one of London's two main airports -- Heathrow and Gatwick -- appear to be stalled due to environmental concerns despite demands for increased capacity.
City airport was bought earlier this year by a consortium of Canadian and Kuwaiti investors from US fund Global Infrastructure Partners.
The sale was announced by Alberta Investment Management Corporation, Ontario Municipal Employees Retirement System (OMERS), and Wren House, an arm of the Kuwait Investment Authority.