The Fed's decision to raise short-term interest rates by another quarter-percentage point to 1.75 percent did not come as a surprise to the market. The widely anticipated decision and the statement issued alongside it were viewed as a signal that the central bank sees continued improvements in the economic outlook and inflation.

"I think it's basically a pretty positive statement," said Sung Won Sohn, a chief economist at Wells Fargo. "I doubt that this hike, which was widely expected, will have any meaningful impact on the economy, but it will have a positive psychological effect on the market, because it is reassuring the world that the economy is doing better."

According to preliminary results, the Dow Jones industrial average closed up 40.04, or 0.4 percent, at 10,244.93.

The broader gauges were also higher. The Standard & Poor's 500 index added 7.10, or 0.6 percent, to 1,129.30, its highest close since July 1. The Nasdaq composite index gained 13.10, or 0.7 percent, to 1,921.17.

In economic news, the Commerce Department reported robust housing construction last month. The 2 million-unit pace of housing construction clocked for August was the highest level of activity in five months, and far outpaced the decline economists were expecting. July's housing figures were revised upward.

The upbeat economic data reinforced Fed Chairman Alan Greenspan's view that the economy is on firmer footing since striking a soft patch in the late spring. In the statement today, the Fed said "output growth appears to have regained some traction, and labor market conditions have improved modestly."

With inflation expected to remain low despite rising energy prices, the Fed governors said they believe "policy accommodation can be removed at a pace that is likely to be measured," language they've used before, which economists interpret to mean rates will continue to rise at a gradual pace. Most economists believe the federal funds rate — the rate banks charge each other on overnight loans — will go up another quarter-percentage point after the presidential election in November.

Persistently high energy prices still continue to weigh heavily on investors' minds. Global supply concerns were further exacerbated by Russian oil giant Yukos' announcement that it would halt shipments to China because of financial troubles related to its ongoing fight with Moscow over back taxes. Light sweet crude for October delivery settled up 75 cents at $47.10.

"The markets seem to be accepting prices over $40 a barrel; if they were to move back to $50 and higher we could see some setbacks, but oil prices at these higher levels have not had a major impact in pushing up inflation so far," said Lynn Reaser senior market strategist at Banc of America Capital Management.