Convening one day after North Korea test-fired its most powerful missile yet, the Bank of Korea's seven policymakers decided to increase the key rate by a quarter of a percentage point to 1.50 percent.
Borrowing rates have steadily fallen during the past five years to help protect the country's recovery, dropping to a record low of 1.25 percent in June 2016.
Thursday's decision was widely expected after third-quarter economic growth beat expectations. The South Korean won has gained against major currencies in the past month in anticipation of the rate hike, which will increase returns for investors.
South Korea's economy is expected to post its fastest growth in three years in 2017, buoyed by surprisingly strong exports thanks to robust global demand for memory chips.
The central bank revised upward its forecast on the South Korean economy in October and says annual growth rate will slightly exceed that estimate. It said in a statement that private consumption and capital spending will continue to improve moderately while exports will be sustained by the global economic recovery and a thaw in strained diplomatic ties with China, South Korea's biggest trading partner.
The outlook is not entirely rosy: slow growth in service sector employment is hampering jobs creation, the bank said.
It said the high and increasing level of household debt from low-interest housing loans was a concern. Growth in such debt has slowed since the government announced plans to regulate the property market but debt levels remain high.
The bank said the decision does not mean an about-face in its monetary stance, adding that it would maintain its accommodative monetary policy while monitoring growth, inflation, central bank policies in major countries and geopolitical risks, among other factors.
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