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  • Jan 31st, 2008
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The Federal Reserve cut US interest rates by a hefty half-percentage point on Wednesday as part of an aggressive effort to halt a sharp slowdown in an economy hit by a housing slump and a credit crunch.

The Fed's action takes the bellwether federal funds rate target to 3 percent, the lowest since June 2005, and comes just eight days after it slashed rates by a bold three-quarters of a point. Wednesday's follow-up reduction was in line with the expectations of many financial market participants.

The cumulative 1.25 percentage point reduction in the benchmark overnight rate in less than two weeks ranks among the most abrupt rate-cutting sprees in the modern history of the US central bank. US stock markets turned positive after the Fed's decision was announced, while prices for short-term government debt rose and the dollar fell. Dallas Federal Reserve Bank President Richard Fisher dissented, preferring to hold rates steady.

"Today's policy action, combined with those taken earlier, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain," the Fed said in a statement outlining its decision. When the Fed lowered rates on January 22 it had cited "appreciable downside risks to growth."

The Fed's action comes on the heels of a government report showing that the economy grew at a weak 0.6 percent annual pace in the last three months of 2007 as consumers curbed spending and homebuilding plunged. Growth of 2.2 percent for all of 2007 marked the economy's weakest expansion in five years. At the same time, a report showing private-sector employers added three times as many jobs as expected in January and a report earlier this week showing a big rise in orders for US-made durable goods pointed to some economic resilience.

Policy-makers are concerned a period of protracted financial market turmoil and tighter credit could lead businesses and consumers to retrench. "Financial markets remain under considerable stress, and credit has tightened further for some businesses and households," the Fed said. "Moreover, recent information indicates a deepening of the housing contraction as well as some softening in labour markets."

In August, rising defaults on US subprime mortgages led to a seizing up of credit markets. While conditions have improved, aftershocks from the subprime mortgage crisis have continued and financial markets remain volatile.

The latest wrinkle in the unfolding saga of exposure to bad debts was the possibility that bond insurers could suffer ratings downgrades, leading to more losses at banks. US stock markets stumbled earlier this month, although equities prices have stabilised since the Fed's surprise rate cut on January 22.

The drop in the housing market continues to be gut-wrenching. Sales of new single-family homes fell 4.7 percent in December to the slowest annualised rate since 1995, the government said on Monday. For last year as a whole, sales were off a record 26 percent, even though builders slashed prices.

Copyright Reuters, 2008

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