The RBA board met in Sydney on Tuesday to decide whether to lift rates for a third consecutive month, a move not seen since 1990.
Reserve Bank Governor Glenn Stevens said the increase was due to recent economic data which indicates Australia's economy is emerging from the global financial crisis much sooner and stronger than initially expected.
"With the risk of serious economic contraction in Australia having passed, the Board has moved at recent meetings to lessen gradually the degree of monetary stimulus that was put in place when the outlook appeared to be much weaker." he said.
"In Australia, the downturn was relatively mild, and measures of confidence and business conditions suggest that the economy is in a gradual recovery." he said.
While the December increase is the third consecutive monthly rate rise, economists and financial markets had largely predicted the move following a sharp improvement in consumer and business confidence, and signs of a return to stock market stability.
"Prospects for ongoing expansion of private demand, including business investment, have been strengthening. There have been some early signs of an improvement in labour market conditions. The rate of unemployment is now likely to peak at a considerably lower level than earlier expected." he said.
Mr Stevens noted inflation had declined from its peak in 2008, helped by a fall in commodity prices and a noticeable slowing in private sector labour costs.
"In underlying terms, inflation should continue to moderate in the near term, though it will probably not fall as far as thought likely six months ago," he said.
But he warned that the headline year-on-year consumer price index (CPI) had been unusually low because of temporary factors, and will probably rise over the coming year.
"Both CPI and underlying inflation are expected to be consistent with the target in 2010," Mr Stevens said.
"The rise in the exchange rate during this year will have some impact in containing prices for traded goods and services in the period ahead, and will dampen growth in the trade-exposed sector of the economy."
Meanwhile, lending for housing was expanding at a solid pace, even as dwelling prices had risen significantly.
Business credit had fallen as companies reduced leverage in an environment of tighter lending standards, and as some lenders scaled back.
"The decline in credit has been concentrated among large firms, which generally have had good access to equity capital and, more recently, to debt markets," Mr Stevens said.
"Share markets have recovered significant ground, which, together with higher dwelling prices, has meant a noticeable recovery in household wealth."
The board will not meet again until February next year, where economists are already predicting another rise.
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