Fed cuts key interest rate

WASHINGTON – The Federal Reserve slashed its benchmark interest rate today by three-quarters of a percentage point to 2.25%, the lowest level in three years, in an aggressive attempt to contain the economic damage from the housing downturn and Wall Street’s credit crisis.

The bank indicated that it was likely to keep cutting rates in the coming months despite the danger of sparking inflation.

“Today’s policy action, combined with those taken earlier, including measures to foster market liquidity, should help to promote moderate growth over time and to mitigate the risks to economic activity,” the Fed said in a statement.

The reduction in the federal funds rate – which banks charge each other for overnight loans – was the second time in three days that the central bank had loosened the reins on credit. On Sunday night, the Fed lowered the discount rate, which the central bank charges when it loans directly to banks, by a quarter-point to 3.25%. The Fed lowered that rate again today by an additional 0.75 of a point to 2.5%.

“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 Fed said.

The Fed’s policy committee voted 8-2 to approve the cut in the federal funds rate, with the two dissenters arguing for a smaller reduction.

“Inflation has been elevated, and some indicators of inflation expectations have risen,” the Fed said. “Uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully.”

As recently as last week, economists had predicted a more modest half-point cut. But the near-collapse of brokerage firm Bear Stearns Cos. spooked Wall Street, prompting calls for as much as a one-point cut.

The stock market, which rallied sharply early today on expectations of a major rate cut, retreated after the decision was announced but then rebounded. The Dow was trading up more than 300 points in the last hour of trading.

In Jacksonville, Fla., President Bush expressed confidence that the economy’s troubles would be short-lived.

“I want people to understand that in the long run, we’re going to be fine,” Bush said.

maura.reynolds@latimes.com