The central bank has slowed the pace of rate hikes, lifting the official cash rate by 25 basis points despite expectations of another 50 basis point jump.
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The 0.25 percentage point lift is the sixth rate hike in a row and brings the cash rate to 2.6 per cent.
The surprise move makes it the first major central bank to start scaling back rate hikes.
Reserve Bank of Australia governor Philip Lowe said the cash rate has increased substantially in a short period of time.
"Reflecting this, the Board decided to increase the cash rate by 25 basis points this month as it assesses the outlook for inflation and economic growth in Australia," he said on Tuesday.
The Australian Stock Exchange rose after the RBA's surprise decision, with the S&P/ASX200 index up 3.44 per cent within minutes.
The benchmark index closed up 242.4 points, or 3.75 per cent, in its best daily gain for more than two years.
The slower pace of monetary policy follows four consecutive 50 basis point rate hikes, and suggests the RBA is getting closer to its "neutral" setting.
This is a level where interest rates neither have a stimulatory nor contractionary effect on the economy.
Dr Lowe said the 25 basis point lift was necessary to bring inflation back down and there would be more rate hikes to come.
He said the size and timing of its rate decisions would be informed by incoming data.
"(The board) is closely monitoring the global economy, household spending and wage and price-setting behaviour."
Treasurer Jim Chalmers also expects top see more rate increases.
"Interest rate rises often have a lag effect, and so the effect of rising interest rates is often not immediate," Dr Chalmers told reporters in Canberra.
"Clearly the Reserve Bank board needs to take that into consideration as well."
He said the latest rate rise and darkening clouds over the global economy would set the backdrop for a "responsible" budget in October.
Commenting on the fallout from the "mini-budget" introduced in the UK, Dr Chalmers said it served as a warning.
"What's happening in the UK is a cautionary tale of getting that fiscal and monetary balance out of whack," he said.
While smaller than expected, the October rate hikes will still hurt mortgage holders.
NAB, Westpac and Suncorp have already passed on the full 0.25 percentage point RBA hike to their variable mortgage rates.
Shadow treasurer Angus Taylor said the latest rate rise was lower than expected but still harmful to Australian households.
"With an upcoming budget, we want to see a budget that does not add fuel to the fire of the pressures that Australians are feeling, and that is not creating price wage spirals that make products unaffordable for Australians," Mr Taylor told reporters.
A 50 basis point lift was broadly expected, although some economists were hoping to see a smaller rate rise in fear of heavy-handed tightening causing a recession.
AMP Capital's Shane Oliver said aggressive hiking of rates risked throwing the economy into an avoidable recession.
ANZ economist David Plank said the slower pace of tightening may extend the tightening cycle for longer.
The bank's economists are of the view that the bank will need to get the cash rate above 3 per cent to bring inflation back within target.
"We still expect the RBA to tighten by 25bp in November, taking the cash rate target to 2.85 per cent," Mr Plank said.
"But there is a bigger question mark over whether the RBA will go again in December as we previously expected."
Australian Associated Press
