Chairman of the U.S. Federal Reserve Ben Bernanke. The Fed has now cut overnight rates, their key economic policy lever, by a full percentage point since mid-September in an effort to put a floor under an economy increasingly seen at risk of falling into recession. - Reuters

The United States Federal Reserve cut a key interest rate by one quarter of a percentage point Tuesday, trying to keep the country out of recession.

The reduction in the Federal funds rate to 4.25 per cent marked the third rate cut in the past three months. Fed officials signalled that further cuts were possible if a severe downturn in housing and a crisis in mortgage lending get worse.

Commercial banks were expected to quickly match the latest reduction by trimming their prime lending rate, which would reduce this benchmark rate for millions of consumer and business loans to 7.25 per cent.

In addition to cutting the funds rate, the Fed announced it was reducing its discount rate, the interest it charges to make direct loans to banks, by a quarter-point as well, to 4.75 per cent.

Aim of reduction

This reduction was aimed at encouraging banks to borrow more freely from the Fed at a time when there are worries that a rising number of bad loans will prompt banks to tighten credit conditions too severely, adding another strain on the already fragile economy.

The Fed embarked on this round of rate cuts in September in response to severe turbulence in credit markets around the globe as investors reacted to various reports of mounting losses from defaults in subprime mortgages, the latest fallout from the worst slump in the U.S. housing market in more than two decades.

After cutting the funds rate by a half-point on September 11 and a quarter-point on October 31, the central bank indicated that those two reductions might be all that were needed to combat the threat of a recession given that financial markets appeared to be stabilising.

However, increased market turbulence following the October meeting and growing fears of a recession caused the Fed to do an about-face.

- AP