BBC News
watch One-Minute World News
Last Updated: Tuesday, 11 December 2007, 22:44 GMT
Q&A: US interest rate decision
Federal Reserve Chairman Ben Bernanke
Mr Bernanke's economic statements are being closely watched
The US central bank, the Federal Reserve, has cut interest rates from 4.5% to 4.25%.

It is the third time in a row the Fed has reduced interest rates in the world's largest economy.

The key rate is now 1% lower than it was at its peak in August, when it stood at 5.25%.

We examine why the Fed cut rates, and why it matters for the rest of the world

What has the US central bank done?

The Federal Reserve has trimmed interest rates for the third month in a row, suggesting how seriously it is taking the problems in the credit and housing markets.

The bank also cut its primary discount rate - the rate it lends money to banks - from 5% to 4.75%.

In comments that accompanied the decision, it indicated that the continued slump in US house prices and the contagion from mortgage defaults through the financial sector was heightening the risks of a severe downturn in the US economy.

After last month's quarter point rate cut, Fed Chairman Ben Bernanke was relatively upbeat about growth prospects.

He suggested that another interest rate cut was not likely with the need to control inflation becoming more of a priority.

But the Fed's mood has changed, with policy makers now preparing for worse economic conditions.

Why does the Fed decision matter?

Many experts believe that only a substantial cut in interest rates by the Fed would have been enough to calm the turbulence in the world's financial markets.

The decision sends a strong signal that the US authorities are prepared to intervene to stabilise the markets and to prevent the US economy sliding into recession.

And it will reassure banks and governments around the world that the US was prepared to take a lead in tackling the current crisis.

How does a rate cut help?

By cutting rates, the Fed is boosting the US economy by making it cheaper to borrow money.

It is also taking the pressure off companies and banks who are suffering a credit crunch: they find it difficult to borrow money to finance their normal operations due to fears of looming bad debts in the system.

And it might help stabilise the US housing market, which is tumbling as a result of the sub-prime scandal, where too much lending was made to individuals that were not credit-worthy.

Many of these households are now in default, and with banks beginning to repossess their homes a glut of unsold homes is depressing the property market.

Why does it matter to the rest of us?

The US is the world's largest economy, so a slowdown in growth there could affect the prospects for the economy in Europe and Asia.

And the fears about bad credit risks in financial markets have already spread to the banking sector in Europe and the UK.

The Fed move also signals that interest rates are likely to be cut across the world, at least in the short-term, to prevent the crisis getting worse.

Will it work?

It is not certain that even three rate cuts will be enough to either calm the markets or avoid an economic downturn in the longer term.

In particular, the US housing market is now so fragile that even lower rates may not persuade people to buy houses right now - and a big slowdown in housing and construction is already having a knock-on effect on the economy.

And until the banking system reveals the full extent of its potential losses from bad debts, there will still be the potential for further panics.

And that makes it more likely that other central banks, like the Bank of England, may have to cut rates sooner rather than later in order to reduce the risk that the crisis will continue.

RELATED INTERNET LINKS
The BBC is not responsible for the content of external internet sites



FEATURES, VIEWS, ANALYSIS
Has China's housing bubble burst?
How the world's oldest clove tree defied an empire
Why Royal Ballet principal Sergei Polunin quit

PRODUCTS & SERVICES

Americas Africa Europe Middle East South Asia Asia Pacific