Fed cuts US interest rates

The US Federal Reserve has cut its base federal funds rate a half point to 4-point-75 per cent in the face of housing and credit market stress that threatens the world's biggest economy.

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The Federal Open Market Committee has also cut its discount rate for direct central bank loans 50 basis points to 5.25 per cent.

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It says economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally.

It says today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.

The cut in the federal funds rate is likely to lead to a lowering of borrowing costs across the US economy for consumers and businesses alike.

The Fed, which hadn't cut rates since 2003, had held the rate at 5.25 per cent since June last year.

The committee was widely expected to cut interest rates to ease stress in the housing and credit markets and to head off a potential recession.

But analysts were divided on whether the central bank would move by a quarter point or a bolder 50 basis points.

Inflation risks

Some economists said a cut might fuel inflation, or bring back the easy-money conditions that created the problems.

The FOMC statement cited some improvement in inflation but added that "some inflation risks remain," and that it would "monitor inflation developments carefully."

Stocks surged on the news, with the Dow industrials rallying 2.5 percent, while the dollar weakened. On the bond market, yields on long-term Treasuries were higher despite the rate cut.

"Bonds are acting in a way to raise long-term mortgage rates, not to cut them," said Robert Brusca at FAO Economics.

Morgan Keegan bond analyst Kevin Giddis said he found the Fed action "puzzling" in view of inflation risks.

"The long end of the bond market gets it," he said. "A cut that is this aggressive will likely lead to inflation and ultimately, a Fed tightening."