The US Federal Reserve slashed its key federal funds short-term interest rate by three quarters of a percentage point to 3.50 per cent Tuesday amid sharp falls on global stock markets.
The Fed announced its surprise move shortly before US stock markets were due to open for trading and amid increasing fears that the world's largest economy, hit by a severe housing slump, could be sliding into a recession.
The Fed has cut rates in prior months, but not as drastically as the cut announced Tuesday by the Washington-based central bank.
"The committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth," the Fed said in a statement.
The rate cut was approved by the Federal Open Market Committee (FOMC) presided over by Fed chairman Ben Bernanke.
In a related move, the Fed also announced it had approved a cut of three quarters of a percentage point in the discount rate to 4.00 per cent. Commercial banks borrow money directly from the Fed through the so-called discount window.
"While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households," the central bank said.
"Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets," the Fed said.
The sharp rate cut comes after some Wall Street investors had urged Bernanke to cut borrowing costs amid increasing economic uncertainty.
The US economy has been buffeted by a two-year-long housing slump and in more recent months by a related credit crunch, rising energy costs and sharp stock market falls.
Futures trading indicates US stock markets will slump heavily when morning trading commences.
A majority of FOMC members including Bernanke approved the surprise rate cuts, but one FOMC member, William Poole, dissented.
The Fed has now cut the fed funds rate by 1.75 basis points since September in a bid to underpin economic momentum.
The central bank's statement said Fed officials would continue to closely monitor economic developments and US financial markets and said that officials would "act in a timely manner as needed" to address ongoing risks.
It is unusual for the central bank to tweak borrowing costs outside of a scheduled rate policy meeting. The bank is due to meet January 29-30 to debate its rate stance.
Surprise Fed rate cut to 3.5%