The Associated Press and
RedwoodAge.com

The Federal Reserve cut a key interest rate by one-quarter of a percentage point Tuesday, trying to keep the country out of recession but disappointing many Wall Street investors who had hoped for a half-point cut.

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

After gaining more than 900 points in the past two weeks, the Dow Jones Industrial Average lost more than 200 points after the Fed's announcement.

Cutting the interest rate effectively makes money "cheaper" for business, lubricating the wheels of industry. However, the value of the US dollar - already under pressure in international markets - could face a further downturn if other central banks don't follow the Fed's lead.

A weaker dollar makes US-made goods more attractive overseas, but raises the cost of importing cars, oil and other products from foreign markets like China. The Fed is normally wary of cutting rates if it thinks inflation will result.

US 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 percent.

The Fed started cutting rates in September with a bolder-than-expected half-point move and then reduced the funds rate by a quarter-point at its Oct. 31 meeting. The central bank was trying to make sure that a severe slump in housing, spreading mortgage defaults and financial market turbulence which hit with force in August did not derail the economy.

Fed Chairman Ben Bernanke and his colleagues began their final meeting of 2007 behind closed doors Tuesday morning. Wall Street investors traded cautiously as they awaited the announcement.

In its October announcement, the Fed indicated that its two rate cuts might well be all that would be needed to make sure the country was not pushed into a recession.

But that view has undergone a dramatic about-face in the six weeks since that time, reflecting worsening conditions in financial markets and continued sharp declines in housing as lenders tighten standards in response to rising mortgage defaults.

Many analysts believe the current quarter and the early part of next year will represent the period of maximum danger for a possible recession.

"I think a full blown recession can be avoided but just barely," said David Jones, chief economist at DMJ Advisors. He predicted that the Fed will follow up its expected December rate cut with three more reductions at its first three meetings of 2008.

For all of 2008, a forecasting panel of the Securities Industry and Financial Market Markets Association said Monday it believed overall economic growth, as measured by the gross domestic product, would come in at an anemic 2.1 percent as housing construction and sales continue to fall for most of the year. That would be the weakest GDP growth in six years.