WASHINGTON (Reuters) - The U.S. Federal Reserve on Tuesday slashed a key interest rate by the biggest amount in more than 23 years in an emergency bid to head off a U.S. recession and halt a global rout in stocks.
In a rare action between regularly scheduled meetings, the U.S. central bank cut the benchmark federal funds rate by three-quarters of a percentage point to 3.5 percent, its lowest level since September 2005.
The Fed also signaled it stood ready to lower rates further to deal with "appreciable" downside risks to growth, and financial markets saw a good chance that policy-makers would take rates down by another half point at its next scheduled meeting on January 29-30.
"The Fed is very, very, very worried," said John Tierney, an analyst at Deutsche Bank in New York.
The Fed's bold bid before U.S. markets opened -- which some analysts said smacked of panic -- helped instill a bit of confidence in shaken financial markets, but did not stop U.S. stocks from sliding.
The Dow Jones industrial average initially plummeted 465 points but clawed back to just about 130 points, or 1.1 percent, down by midafternoon. European shares, which suffered big losses on Monday when U.S. markets were shut, closed higher.
Tuesday's action was the biggest cut in the federal funds rate, which governs overnight lending between banks, since October 1984. The Fed also lowered the discount rate it charges on direct loans to banks by a matching amount to 4 percent.
"The committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth," the Fed said, referring to its policy-setting Federal Open Market Committee.
"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," it said.
U.S. Treasury Secretary Henry Paulson said the Fed's move should help rebuild investor confidence. "This is very constructive and I think it shows this country and the rest of the world that our central bank is nimble and can move quickly in response to market conditions," he said.
The Fed had faced heated criticism from some on Wall Street for failing to move quickly and aggressively enough to put a floor under an economy already beset by a deep housing slump once credit market strains erupted last summer.
"One is tempted to say, 'Better late than never.' The problem is that such a belated move is now insufficient," said Bernard Baumohl, managing director of the Economic Outlook Group in Princeton Junction, New Jersey.
"The Fed and other major central banks need to act more quickly and decisively if they are to prevent a severe and prolonged global economic downturn," he said.
Until Tuesday, the Fed had cut rates by one percentage point since it began easing monetary policy four months ago. It had cut rates by two full percentage points in the first four months of its previous easing cycle, which started in January 2001, just before the United States slipped into recession.
Shortly after the Fed announced it was lowering U.S. interest rates, the Bank of Canada cut its key overnight interest rate by a quarter percentage point to 4 percent and said further cuts were likely to be needed.
Even after the Fed's move, interest-rate futures markets showed a 74 percent chance of another half-percentage point reduction in U.S. rates next week. They also pointed to a federal funds rate of 2.25 percent by midyear.
"Appreciable downside risks to growth remain," the Fed said. "The committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks."
"Incoming information indicates a deepening of the housing contraction as well as some softening in labor markets," it said.
The cut in the federal funds rate was the first between regularly scheduled Fed meetings since September 17, 2001, the first day U.S. financial markets reopened after the September 11 attacks.
The Fed only began to set an explicit target for the federal funds rate around 1990. Previously, it manipulated the money supply to influence bank lending rates.
And the bank did not start announcing federal funds rate changes until 1995, signaling its policy stance before that through discount rate changes.
Tuesday's discount rate cut was the largest since it cut the discount rate by a full percentage point in December 1991.