Chairman of the US Federal Reserve Ben Bernanke. - Reuters

The Federal Reserve cut a key interest rate for the first time in four years, starting with an aggressive half-point move to prevent a steep housing slump and turbulent financial markets from triggering a recession.

The action provoked a huge rally on Wall Street.

The Fed announced Tuesday that it was reducing its target for the federal funds rate, the interest that banks charge each other, from 5.25 per cent to 4.75 per cent.

The half-point reduction was double the quarter-point move that many had expected and sparked euphoria among investors, who had been worried that the central bank would be too slow in responding to recent market turmoil.

The Dow Jones industrial average, which was up by 84 points right before the Fed decision, soared by more than 300 points following the mid-afternoon announcement.

The Fed's action is designed to boost economic growth by lowering borrowing costs for millions of consumers and businesses. Commercial banks followed quickly with announcements that they were slashing their prime lending rate by a half-point to 7.75 per cent. It had been at 8.25 per cent for the past 15 months.

Economists predicted more rate cuts to come until the Fed is satisfied that it has done enough to keep the economy out of a recession.

"I think this shows they are really getting concerned about the meltdown in financial markets," said David Wyss, chief economist at Standard & Poors in New York.

The Fed's action came in the midst of the worst slump in housing in 16 years. That downturn has triggered record defaults in subprime mortgages and roiled financial markets around the globe as investors have become worried about where the spreading credit problems will next appear.

Federal funds

The financial market turmoil represents the first major test for Fed Chairman Ben Bernanke, who took over from the venerable Alan Greenspan in February 2006.

In addition to cutting the federal funds rate by a half point, the central bank also reduced its discount rate, the interest it charges in making direct loans to banks, by a half-point as well.

The Fed had also cut the discount rate on August 17 as it scrambled to respond to the growing credit crisis.

In explaining its action Tuesday, the Fed said that "the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally".

Many analysts had predicted that Bernanke, who has been cautious since taking over as Fed chairman, would opt for a quarter-point move, the change in rates usually preferred by Greenspan.

But with this action, Bernanke appeared to be trying to surprise financial markets with a positive change after disappointing investors following the August 7 meeting when he and fellow board members refused to change rates and still said inflation was the biggest threat facing the economy.

"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 Fed said in a brief statement explaining its actions.

- AP