Fed cuts key interest rates by 3/4 point

By Mark Felsenthal

WASHINGTON (Reuters) - The Federal Reserve slashed a key U.S. interest rate by three-quarters of a percentage point on Tuesday, a substantial cut but smaller than many in financial markets had expected, as part of an effort to hold off a deep recession and financial meltdown.

The Fed's action, taken on an 8-2 vote of its policy committee, took the bellwether federal funds rate down to 2.25 percent, the lowest since February 2005. Financial markets had largely priced in a full point reduction.

"Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters," the central bank said in a statement outlining its decision.

The Fed also said downside risks to economic growth remained even in the wake of the rate cut, suggesting an openness to a further lowering of borrowing costs if needed.

However, two Fed officials dissented, preferring less-aggressive action. Still, most policy-makers seemed to be counting on inflation to subside, partly because they expect unemployment to rise.

"The committee expects inflation to moderate in coming quarters, reflecting a projected leveling out of energy and other commodity prices and an easing of pressures on resource utilization," the Fed said.

U.S. stock markets trimmed earlier gains on the smaller-than-expected rate cut, but were still up sharply. Prices for short-term government debt extended losses and the dollar pared earlier gains against the Japanese yen.

"The Fed has shown that they are focused on getting the economy back on its feet first and foremost, and they will worry about inflation later," said K. Daniel Libby, senior portfolio manager at Sands Brothers Select Access Fund in Greenwich, Connecticut.