In raising its benchmark overnight lending rate a quarter of a percentage point to a range of 1.75 per cent to 2 per cent, the Fed dropped its pledge to keep rates low enough to stimulate the economy "for some time" and signalled it would tolerate inflation above its 2 per cent target at least through 2020.
In its quarterly Summary of Economic Projections, officials projected the Fed's preferred inflation measure will accelerate only slightly, ending this year at 2.1 per cent rather than 1.9 per cent, and holding at that level through 2020.
That implies four total rate increases this year.
Growth is also expected to stay close to nearly 3 percent of GDP through the year, and Fed officials are eager to prevent the economy from overheating.
Fed Chairman Jerome Powell is scheduled to hold a press conference at 2.30pm EDT (18.30 GMT). The labor department reported Tuesday, just as the Fed was meeting, that the consumer price index had risen by 2.8% from a year earlier, the biggest annual gain since February 2012.
Yields rose after Fed officials raised their estimates for the pace of growth and inflation this year while also lowering their estimate for the unemployment rate.
The increase marks the highest level of interest rates in the United States since 2008.
The vote to raise interest rates was unanimous among all eight participants. "Powell seems comfortable exploring the lower reaches of the unemployment rate given few indications it is resulting in stronger inflation pressures".
However, higher rates would help savers earn more interest on their deposits.
The Fed now foresees four rate hikes this year, up from the three it had previously forecast.
"The Fed deserves tremendous credit for steering the economy to calmer waters, supporting what is likely to be the longest expansion in US history while meeting inflation and employment objectives", said Stephen Gallagher, chief USA economist at Societe Generale. When the Fed tightens credit, it aims to do so without derailing the economy. "Higher rates and higher payments will squeeze the buying power of households without a compensating increase in wages". But if it miscalculates and overdoes the credit tightening, it can trigger a recession.
"The decision you see today is another sign that the economy is in great" shape, Powell told reporters following the decision. It will become the longest if it lasts past June 2019, at which point it would surpass the expansion that lasted from March 1991 to March 2001. It would also allow the Fed to be less choreographed and more spontaneous in cutting or raising rates as economic conditions warrant. Canada, the European Union and Mexico have all pledged to retaliate with tariffs on USA imports, which some studies show could cost the US close to 200,000 jobs.
The Fed's meeting this week is to be followed by policy meetings of two other major central banks - the European Central Bank on Thursday and the Bank of Japan on Friday.