The once unthinkable prospect of zero interest rates moved closer to reality yesterday. The US Federal Reserve announced an historic reduction in borrowing costs, pushing American interest rates to a level below which they have not been since the mid-1950s.

The Fed’s decision to reduce its target for the Federal Funds rate, the main rate at which banks lend to each other overnight, by 0.5 percentage points to 1 per cent, was widely expected by financial markets.

But more striking was the clear accompanying signal from the central bank that it stood ready to lower rates even further in the face of the most difficult financial and economic climate in decades.

Explaining its decision, the Fed’s policymaking Open Market Committee cited a long list of economic woes, from the continuing credit squeeze to weakness in countries around the world.

Looking to the future economic climate, the policymakers said: “Downside risks to growth remain.” This was a hint that the next move in rates is more likely to be down.

With the cost of borrowing at 1 per cent, that suggests the strong probability that the US central bank will push rates all the way down to nothing if it has to in the next few months.

The US has not had zero interest rates in its modern economic history, although Japan, faced with a similarly challenging financial environment in the 1990s, held rates at that level for several years.

Key to the Fed’s decision has been the ebbing of the inflation threat in the past month as energy and other costs have fallen sharply. Perhaps most significant in the Fed’s statement was that for the first time in more than two years Ben Bernanke, the central bank chairman, and his colleagues indicated that inflation was no longer something they were worried about.

After every Open Market Committee meeting since 2006, the Fed has expressed concern in some form about the inflation outlook. But yesterday it said, in effect, that the war on inflation was over: “In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate in coming quarters to levels consistent with price stability.”

US market interest rates are now as low as they have been since the Second World War. From mid-2003 the central bank held the Fed Funds rate at 1 per cent for a year in the wake of fears about deflation after the collapse of the stock market bubble in 2000-2001. Rates have not been below 1 per cent since 1954, when Dwight D. Eisenhower was President.

With the Fed’s aggressive rate cut, attention now shifts to other central banks. Most financial market economists believe the European Central Bank and the Bank of England both need to cut rates sharply. The world is now in such parlous economic shape and the leading economies are so interconnected that monetary easing in one country will not suffice to avert a serious recession. US officials have been gently pressing their colleagues overseas to do more to cushion their economies from the effects of the financial crisis.

The Fed, the Bank of England and the ECB, along with other central banks, cut rates in a co-ordinated emergency move three weeks ago. The Bank and the ECB are expected to cut rates again next week. Meanwhile, the Chinese central bank has cut rates several times in the past month. It, too, is likely to go much farther in an effort to avert a serious slump.

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