Fed cuts rates to record low

By Mark Felsenthal

WASHINGTON (Reuters) - The U.S. Federal Reserve on Tuesday broke into uncharted territory as it chopped benchmark interest rates to as low as zero and pledged to use "all available tools" to turn back a deepening recession.

In a surprise and historic move, the Fed lowered its target for the interbank federal funds rate to a range of zero to 0.25 percent, a record low, from 1.0 percent, and said it was willing to keep rates low for an extended period.

"The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability," the Fed said.

The U.S. economy is mired in a year-old recession that some fear could prove to be the worst since the Great Depression.

With the contraction worsening, inflation slowing, and no signs a housing market collapse is abating, officials felt a need to move decisively, and they signaled a willingness to buy potentially huge amounts of debt in an unconventional move to drive down private borrowing costs.

"The Fed has realized that there is one entity left to bring the financial system in line," said Jessica Hoversen, fixed income market analyst at MF Global Research in Chicago. "It has to be the Atlas of the world to bear the weight of the financial system on its shoulder."

The Fed's announcement spurred a big rally in U.S. stocks, with the blue chip Dow Jones industrial average closing up 359 points, or 4.2 percent. Prices for U.S. government debt also shot higher, pushing yields to record lows.

The central bank's unanimous decision undercut the U.S. dollar, which fell to a fresh 2-1/2 month low against the euro. The European Central Bank has held rates at 2.5 percent, the highest in the Group of Seven developed economies.

In addition to the rate cut, the Fed said it was prepared to expand a plan to purchase debt issued or guaranteed by government-sponsored mortgage agencies. It also said it was mulling purchases of longer-term U.S. Treasury debt and would consider other ways to tap its burgeoning balance sheet to support the economy.

The extraordinary measures the Fed is taking and a massive stimulus plan outlined by President-elect Barack Obama represent a form of shock therapy for the world's biggest economy, which could in turn help growth elsewhere.

Financial markets had expected the Fed to lower rates by no more than three-quarters of a point.

OPENING FRESH FRONT IN CRISIS

"Weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time," the Fed said, offering a policy commitment aimed at bringing long-term market-set interest rates down.

In the wake of the Fed's action, interest rate futures prices were implying an unusually low level of rates through next year, with an end-2009 rate of just 0.69 percent.

A Reuters poll of 11 top Wall Street firms that deal directly with the Fed in the markets found none of them believed rates would begin rising before the second half of 2009 and several see rates on hold well into 2010.