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Last Updated: Tuesday, 11 December 2007, 23:12 GMT
US rates reduced for third time
Graph of US interest rates
The Federal Reserve has cut US interest rates from 4.5% to 4.25% to help steer the world's largest economy through a housing slump and credit woes.

It is the third rate cut in the US in as many months, leaving US rates 1% lower than their August peak.

A downward move had been expected, but US shares fell as traders bet that the cut would fail to prevent a recession.

The Fed also trimmed the rate at which it lends money to banks to help smooth out problems in the credit markets.

The Fed reduced its primary discount rate from 5% to 4.75% to encourage banks to borrow from it.

This is designed to boost the amount of money in the financial system, making it easier for banks to borrow from each other.

Recent developments have increased the uncertainty surrounding the outlook for economic growth and inflation
Federal Reserve

Inter-bank lending charges have shot up recently amid suspicion over which banks are bearing undisclosed losses linked to investments in bad home loan debt.

The need to shore up capital reserves has also underpinned the credit freeze.

The fear is that these problems will prompt banks to increase their charges on credit cards and commercial loans to protect their profits, which will suffocate consumer spending and make it more difficult for companies to trade.

The US consumer is vital to the country's economic wellbeing and households are already struggling to cope with increased mortgage repayments and more expensive utility bills.

Share sell-off

The Fed's twin actions are designed to prevent the US economy from slipping into a recession next year, which could have potentially damaging consequences for economic growth around the world.

But one Fed policy maker Eric Rosengren, president of the Federal Reserve Bank of Boston, thought that the move was not bold enough.

He voted for a more extreme half-percentage point cut which would have taken the rate to 4% - a level not seen since the end of 2005.

Many traders had also hoped for more aggressive intervention and all three indexes on Wall Street sank in a similar vein to the steps taken in September, when the Fed reduced rates from their five-year high at 5.25% to 4.75% - the first rate cut in four years.

The Dow Jones Industrial Average index plunged 2.14% and closed at 13,432.8 following the announcement, while the broader S&P 500 index dropped 2.6% at 1,477.65 and technology-dominated Nasdaq also fell more than 2% at 2,652.35.

"A quarter point isn't a heck of a lot and the stock market is concerned there isn't enough liquidity," said Robert Macintosh, chief economist at Eaton Vance.

"I just don't know what a quarter point will accomplish."

Global oil prices had surged before the Fed's announcement amid pipeline shutdowns in the US due to weather problems and a bomb attack in Algeria, a key oil exporter.

New York sweet, light oil jumped more than $2 to trade past the $90 level, while Brent crude in London also surged up $1.90, to $89.94.

Energy traders have been divided in recent weeks over the direction of oil with the bulls betting that supply will be tight during the cold winter months, while others see demand for energy contracting as the US economy shrinks.

Downturn feared

The Fed warned that recent economic data indicated a slowdown in the US economy as a result of "the intensification of the housing correction and some softening in business and consumer spending".

It added: "Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation."

These sombre comments differ markedly from those made by Fed Chairman Ben Bernanke after last month's interest rate cut when he sounded a relatively upbeat note on the health of the US economy.

Then it was suggested that the greater risks came from inflationary pressures due to higher energy and food prices.

But with no sign of recovery in the housing market since then and the banking system still not functioning under normal conditions, analysts believe the Fed is now preparing for a sharp downturn with more interest rate cuts expected.

"They left open the possibility of additional rate reductions," said Carl Tannenbaum, chief economist at LaSalle Bank.

He expects the next cut could come as soon as the Fed's next meeting in January.

Reaction from traders in the US

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