The Federal Reserve acted last night to stave off a severe US recession, cutting American interest rates to 1 per cent, matching the lowest levels of recent decades and paving the way for further cuts to unprecedented lows.

In its latest aggressive step to shore up the rapidly faltering US economy, the Fed cut its key official interest rate by another half point. The move came on the heels of its half-point reduction on October 8, as part of a concerted wave of rate cuts with other leading central banks.

Last night’s cut left the Fed Funds rate at lows last seen four years ago. But after the Fed coupled its action with a bleak statement on American prospects, economists predicted that US rates will soon tumble to historic lows of 0.5 per cent, and perhaps to zero, within months.

Ahead of key official data today that is expected to show that the US economy shrank in the third quarter, sliding into recession, the Fed admitted that growth had already slowed markedly and sounded a warning of worse to come.

“The intensification of financial market turmoil is likely to exert additional restraint on spending,” the Fed’s statement said, in an acknowledgement of the economic squeeze from harder access to credit for US consumers and businesses. “Downside risks to growth remain,” it added.

The growing likelihood that the Fed will couple still further radical rate cuts with its massive injections of funding into money markets through its lending operations helped to fuel sharp gains for leading US shares. In volatile trading, the Dow Jones industrial average first leapt as much as 2.7 per cent in the wake of the Fed decision, adding to Tuesday’s 11 per cent surge, but later closed down 74.16 points at 8,990.96.

Earlier, blue-chip shares in Europe had registered steep gains amid rising investor optimism that a spate of decisive actions by central banks may limit the size of a global downturn.

In London, the FTSE 100 index leapt by 316.2 points, or 8.1 per cent, to close at 4,242.5. The FTSE was on course for its biggest one-week gain since 2001 but remains down more than 13 per cent over the past month.

The pound rose more than 7 cents against the dollar to close at $1.6297 as the US currency surrendered some of its recent sharp gains.

The Fed’s latest rate move piled pressure on the Bank of England and the European Central Bank to follow suit next week. Both are expected to order half-point cuts next Thursday.

Pressure on the Bank of England to take aggressive action was ratcheted up by David Blanchflower, an external member of its rate-setting Monetary Policy Committee.

In a hard-hitting speech, Professor Blanchflower called for British interest rates to be cut significantly and quickly. “If rates are not cut aggressively, we do face the prospect of a relatively deep and long-lasting recession,” he said. “I believe the impact of constrained credit conditions has yet to fully feed through to the broader real economy . . . The impact of tighter credit conditions has yet to be fully felt by firms and households.” Professor Blanchflower strongly criticised the Bank’s recent record. “Monetary policy has not been sufficiently forward looking,” he said.

Amid growing fears that the US could slide into the grip of Japanese-style deflation, Professor Blanchflower also suggested the same danger could yet confront Britain, arguing that inflation will soon plunge to under 1 per cent “and maybe even negative”.

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