The Fed has decided to raise its benchmark interest rate by 0.25%, from 0.5% to 0.75%, citing a stronger economic growth and rising employment.
This is only the second interest rate increase in a decade.
The central bank said it expected the economy to need only “gradual” increases in the short term.
Fed chief Janet Yellen said the economic outlook was “highly uncertain” and the rise was only a “modest shift”.
However, the new administration could mean rates having to rise at a faster pace next year, Janet Yellen signaled at a news conference after the announcement.
President-elect Donald Trump has promised policies to boost growth through tax cuts, spending and deregulation.
Janet Yellen said it was wrong to speculate on Donald Trump’s economic strategy without more details.
She added that some members of the Federal Open Markets Committee (FOMC), the body which sets rates, have factored in to their forecasts an increase in spending.
As a consequence, the FOMC said it now expects three rate rises in 2017 rather than the two that were predicted in September.
Janet Yellen told the news conference: “We are operating under a cloud of uncertainty… All the FOMC participants recognize that there is considerable uncertainty about how economic policy may change and what effect they may have on the economy.”
Also, the Fed chairwoman declined to be drawn on Donald Trump’s public comments about the central bank, and his use of tweets to announce policy and criticize companies.
“I’m a strong believer in the independence of the Fed,” Janet Yellen told journalists.
“I am not going to offer the incoming president advice.”
The interest rate move had been widely expected, and followed the last increase in 2015.
Rates have been near zero since the global financial crisis. But the US economy is recovering, underlined by recent data on consumer confidence, jobs, house prices and growth in manufacturing and services.
Janet Yellen said the rate rise “should certainly be understood as a reflection of the confidence we have in the progress that the economy has made and our judgment that that progress will continue”.
Although inflation is still below the Fed’s 2% target, it expects the rise in prices to pick up gradually over the medium term.
The Fed also published its economic forecasts for the next three years.
These suggest that the Federal Funds rate may rise to 1.4% in 2017; 2.1% in 2018; and 2.9% in 2019.
GDP growth will rise to 2.1% in 2017 and stay there, more or less, during those years.
The unemployment rate will fall to 4.5% over the 2017-2019 period, the Fed forecast.
Inflation will rise to 1.9% next year and hover at that level for the next two years.
The dollar rose 0.5% against the euro to €0.9455, and was 0.9% higher against the yen at 116.17 yen.
Following the Fed’s announcement, Wall Street’s main stock markets were largely unmoved, but drifted lower later. The Dows Jones index closed down 0.6%, and the S&P 500 was 0.8% lower.
According to official figures, the US economy grew at an annualized rate of 1.4% in Q4 of 2015.
The US Commerce Department revised its Q4 GDP to upward from an initial estimate of 0.7%.
Overall, the US economy is estimated to have grown at a rate of 2.4% for all of 2015.
One reason for the revised figure was greater consumer spending than officials initially thought, boosted by an improving labor market.
Analysts had expected the fourth quarter growth rate to remain unchanged from the last estimate of 1%.
Increased employment has helped to slowly boost wages and housing prices, while low oil prices have increased discretionary spending by US households.
The stronger growth rate could increase the chances of an interest rate hike when the Federal Reserve meets in April. The Fed left rates unchanged at its meeting in March, saying the slowing global economy raised risks for the US market.
US corporate profits dipped 11.5% for Q4 compared to the same October through December period in the previous year.
Companies were hurt by low oil prices, with some industrial and petroleum linked companies forced to cut their workforces or file for bankruptcy.
The US economy contracted in 2014 Q1 to an annualized rate of 1%, official estimates have shown.
It is the worst economic performance since 2011 Q1.
It is also a big fall on the 2.6% rise in economic output in 2013 Q4.
The US Commerce Department’s first reading of gross domestic product (GDP) showed the economy grew at an annualized rate of just 0.1%.
The US economy contracted in 2014 Q1 to an annualized rate of 1 percent
The fall in output was blamed on an unusually cold and disruptive winter – one of the coldest in the US for 20 years – and a plunge in business investment.
Economists estimate the weather could have cost up to 1.5 percentage points of GDP.
However, the Commerce’s Department’s report did not estimate the effect of the winter weather.
The fall was also twice as big as economists expected.
Most Wall Street analysts had forecast the economy to contract by around 0.5%.
But the Commerce Department said there was already evidence that the economy was rebounding, with data ranging from employment to manufacturing activity already pointing to a sharp acceleration in economic activity in the second quarter.
Tumbling exports, while not as severe as initially thought, combined with stronger imports in the first quarter resulted in a larger than expected trade deficit which shaved 0.95 percentage points off US economic output.
Consumer spending, which accounts for more than two-thirds of US economic activity, increased by 3.1%, which was revised up slightly from 3% in the first estimate.
Business spending on non-residential structures, such as gas drilling, fell by 7.5%. It had previously been reported to have increased by 0.2%.
The report showed corporate pre-tax profits also plunged 13.7% in 2014Q1, the biggest drop since the fourth quarter of 2008.
The White House said the GDP revision was subject to a number of notable influences, including the severe winter weather, which temporarily lowered growth.
It added: “The President will do everything he can either by acting through executive action or by working with Congress to push for steps that would raise growth and accelerate job creation, including fully paid-for investments in infrastructure, education and research, a reinstatement of extended unemployment insurance benefits, and an increase in the minimum wage.”
US economic growth slowed sharply in 2014 Q1, growing at an annual rate of 0.1%.
The rate is the slowest for a year and a large fall on the 2.6% increase in gross domestic product (GDP) in the final quarter of last year.
An unusually cold and disruptive winter, coupled with tumbling exports, contributed to the decline, the US Commerce Department said.
But it said economic activity already appeared to be bouncing back.
Business investment fell by 2.1%, with spending on equipment plunging by 5.5% at an annual rate compared with a year earlier.
Residential construction, which was inevitably hit by the unusually cold winter fell by 5.7% although it was also hit by higher house prices and a shortage of available homes for sale.
US economic growth slowed sharply in 2014 Q1
The US trade deficit widened, thanks to a sharp fall in exports which shaved growth by 0.8 percentage points in the first quarter. Businesses also slowed their restocking, with a slowdown in inventory rebuilding reducing growth by nearly 0.6 percentage points.
But consumer spending – which drives 70% of growth in the US economy – grew by 3%, although the increase was dominated by a 4.4% rise in spending on services, reflecting higher utility bills during the bitterly cold winter.
A cutback in spending by state and local governments also helped offset a rebound in federal activity after the 16-day partial government shutdown last year.
But most economists expect a strong rebound in growth in the April-June quarter. The consensus view is the economy will expand by 3% in the second quarter.
Analysts said stronger growth will endure through the rest of the year as the economy derives help from improved job growth, rising consumer spending and a rebound in business investment.
In fact, many analysts believe 2014 will be the year the recovery from recession finally achieves the robust growth needed to accelerate hiring and reduce still-high unemployment.
If the economy rebounds as strongly as they suggest, it will have experienced the fastest annual expansion in the economy in nine years.
The last time growth was as strong was in 2005, when GDP grew 3.4%, two years before the nation fell into the worst recession since the 1930s.
Unemployment is expected to fall to 6.2% by the end of this year from 6.7% in March.
The growth figures come a few hours before a policy statement from the US Federal Reserve, the country’s central bank.
But few expect the disappointing news to have any impact on the scaling back of the Fed’s economic stimulus, which has seen it cut bond purchases by $10 billion per month.