The US Federal Reserve last night ordered its second, aggressive three-quarter-point cut in American interest rates this year as it stepped up its campaign to stave off recession and shore up America’s fragile financial system.

The US central bank, led by its Chairman, Ben Bernanke, cut the key Fed Funds rate to just 2.25 per cent, the lowest since February 2005, in the latest drastic action to limit the growing toll from America’s housing slump and the global credit squeeze.

Following on from its previous, emergency three-quarter-point cut in late January, and a further half-point cut eight days later, last night’s move took the total reduction in official US rates to 3 percentage points in the past six months. Rates have been cut by 2 full points in the past three months alone as market turmoil has escalated and US economic woes have deepened.

The latest step by the Fed’s rate-setting Federal Open Market Committee (FOMC) caps a run of unprecedented policy action by the central bank in recent days as it fights to stabilise US financial conditions and prevent the world’s biggest economy plunging into a severe economic downturn. In a measure not seen since for at least 50 years, those initiatives included opening the Fed’s emergency lending facilities to Wall Street investment banks and prime brokerages as the central bank finalised the rescue of Bear Stearns, the investment bank.

The Fed last night also ordered a parallel three-quarter-point cut in its discount rate on emergency lending, lowering this to 2.5 per cent.

Initially Wall Street reacted edgily to last night’s decision, which dashed investors’ hopes for an even larger cut in the Fed Funds rate of a full percentage point. However, US shares, lifted earlier by better than expected results from Goldman Sachs and Lehman Brothers, then powered on, taking the Dow Jones industrial average 420.40 points higher to close at 12,392.70.

The S&P 500 had its best daily percentage gain since October 2002, rising 54.15 points, or 4.24 per cent, to 1,330.75, while the dollar reversed earlier losses as currency markets reacted to the smaller than predicted rate cut, with the euro sliding by 0.2 per cent to levels around $1.57. Treasury bonds extended earlier losses.

Announcing its verdict, after a split 8-to-2 vote on the FOMC, with two members calling for less radical steps, the Fed said that recent developments suggested that the outlook for the American economy had weakened still further. “Growth in consumer spending has slowed and labour markets have softened,” it noted. “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 sought to reassure markets, insisting that its recent spate of moves should “help to promote moderate growth over time and to mitigate the risks to economic activity”. However, the central bank conceded that those risks could yet grow still worse.

Although the Fed set aside immediate inflation worries in cutting rates further last night, it markedly toughened its language on inflationary dangers, rattling some investors by hinting at limitations on its scope for steep rate cuts to follow swiftly. “Inflation has been elevated, and some indicators of inflation expectations have risen,” it said.

The FOMC said that it still expects inflation to fall back during the coming months, but it also added: “Uncertainty about the inflation outlook has increased.” Yesterday’s action by the Fed came as signs of renewed stress in credit and money markets continued to mount in London.

The key three-month sterling Libor rate for lending between UK banking groups rose to a fresh high for the year, reaching 5.9725 per cent, in an eighth straight day of gains. Mervyn King, Governor of the Bank of England, postponed a planned visit to the West Midlands. The Bank said that he had delayed the visit in order to stay in London “to monitor events”.

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