The Reserve Bank of Australia has raised the cash rate by 0.25 percentage points to 0.35 per cent following Tuesday's monthly board meeting, coming after last week's strong inflation figures.
It is the RBA's first rate increase since November 2010, having held the rate at a record low 0.1 per cent since November 2020.
RBA governor Philip Lowe warned more interest rates are to come to ensure inflation returns to its two to three per cent target.
Economists had expected a more modest 0.15 per cent increase at this meeting, particularly coming in the middle of a federal election campaign.
Dr Lowe said the board judged that now is the right time to begin withdrawing some of the extraordinary monetary support that was put in place to help the Australian economy during the pandemic.
"The economy has proven to be resilient and inflation has picked up more quickly, and to a higher level, than was expected," Dr Lowe said in his post-meeting statement.
"There is also evidence that wages growth is picking up. Given this, and the very low level of interest rates, it is appropriate to start the process of normalising monetary conditions."
Figures released last week showed annual inflation rising 5.1 per cent and underlying inflation increasing to 3.7 per cent - well above the RBA's two to three per cent target.
"This rise in inflation largely reflects global factors," Dr Lowe said.
"But domestic capacity constraints are increasingly playing a role and inflation pressures have broadened, with firms more prepared to pass through cost increases to consumer prices."
A further rise in inflation is expected in the near term.
"A move of 40 basis points in June to take the cash rate target to 0.75 per cent seems a distinct possibility," ANZ head of Australian economic David Plank said following the surprising increase in May.
The RBA's central forecast for 2022 is for headline inflation of around six per cent and underlying inflation of around 4.75 per cent.
By mid 2024, headline and underlying inflation are forecast to have moderated to around three per cent.
"These forecasts are based on an assumption of further increases in interest rates," Dr Lowe said.
"The board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time."
The RBA will release a full set of economic forecasts in its quarterly statement on monetary policy which is due for release on Friday.
The Morrison government put on a brave face to the interest rate rise.
"Most Australians understood it was unlikely interest rates would remain at those emergency levels forever," Assistant Treasurer Michael Sukkar told Sky News.
"It's time to begin the process of normalising monetary policy."
But shadow treasurer Jim Chalmers said the country faces three more years of the same fall in real wages, skyrocketing cost of living and pressure on family budgets under this government.
"This election is a contest between a Labor party with a plan for a stronger economy and a better future versus a Liberal party that is promising nothing," he told reporters in Canberra.
