The rise comes as other major central banks are cutting interest rates to ease an economic downturn.
Australia's resource-rich economy has continued to expand due to a sustained rally in commodity prices.
Chinese demand for raw materials has allowed Australia to lessen its reliance on the United States, which is on the brink of a recession.
The Reserve Bank of Australia has raised the cost of borrowing 11 times since 2002.
"Having both the international and domestic information available, the board concluded that a tighter monetary policy stance was needed now," said Glenn Stevens, the bank's governor.
Prices rising
Inflation is running at an annual rate of 3.6%, above the bank's comfort zone of 2% to 3%.
A recent drought has put pressure on food, water and utility prices while rents have soared amid a strong housing market.
The United States has cut rates aggressively this year in an effort to prevent the economy from falling into a recession.
The Bank of England is expected to cut interest rates after its meeting on Thursday. The European Central Bank has also expressed concerns about growth.
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