(Xinhua)
Updated: 2007-09-19 03:29

WASHINGTON - The US Federal Reserve decided on Tuesday to cut a key interest rate by a half percentage point to 4.75 percent in an effort to calm turmoil in the credit markets and avoid a broader economic downturn.

US banknotes. The dollar steadied in European trade ahead of an interest rate decision from the US Federal Reserve, which is expected to cut American borrowing costs from the current 5.25 percent. [AFP\File]

This was the first cut in the central bank's target for the federal funds rate, the interest rate that commercial banks charge each other for overnight loans, in more than 4 years.

After the Fed's 17 consecutive rate hikes over two years since June 2004, the key short-term interest rate had risen to 5.25 percent from a 46-year low of one percent, where it had stood for one year.

The federal funds rate, which ultimately affects the cost of borrowing money by businesses and consumers through credit card interest rates, commercial loans and more, had been kept steady at 5.25 percent since late June 2006.

Tuesday's decision came as a widening credit crisis has triggered turbulence in global financial markets and increased downside risk to the US economic growth.

The recent credit crunch has stemmed from troubles in the US high-risk subprime mortgage market, which offers loans to people with lower credit and had grown rapidly as sales of both existing and new homes in the country hit records in five years in a row.

However, the once-sizzling US housing market has significantly cooled off since last year, getting into the worst slump in 16 years.

Rising interest rates and falling home prices have made borrowers at the subprime mortgage market, especially those who have taken out adjustable-rate mortgages, increasingly hard to keep up with their monthly payments.

As delinquencies rise, banks are reducing the availability of credit to subprime borrowers and even those with good credit.

"The subprime problem will, in fact become worse," Josh Rosner, managing director at the New York-based institutional research firm Graham Fisher & Co., told Xinhua recently in an interview.

"It is spreading outside of subprime in both the real economy and in financial markets," he said.

Jan Hatzius, chief U.S. economist at Goldman Sachs Group Inc., was quoted Monday by The Wall Street Journal as saying that "We should expect further problems in the financial markets from the housing troubles."

Today's trouble "is more serious than 1998, by a significant margin," he said.

A survey of economists published last week by WSJ.com put the risk of a US recession at 36 percent, up from 28 percent a month earlier.

While most economists don't expect recession, they worry that the combined effects of the credit crunch and the housing mess will hold back consumer spending, business investment and corporate profits, which is bad news for stocks.

In the face of the crisis, the European Central Bank stepped back from plans to boost its own key rate at the beginning of September.

On Monday, US Treasury Secretary Henry Paulson said that the current turmoil on financial markets would persist for a while longer but the overall global economy remains healthy.

Economists believe that the credit crisis and the housing slump could affect the overall economy significantly.

Mark Zandi, chief economist at Economy.com., predicts that the US economic growth will slow to around 2.5 percent in the July- to-September period from 4 percent pace in the second quarter.

Growth rate in the fourth quarter is likely to be even weaker at around 1.5 percent, he forecasts.