The U.S. Federal Reserve on Tuesday cut a key interest rate by a quarter percentage point to 4.25 percent, the third rate reduction in three months, in an effort to prevent the economy from sliding into recession.

Since Sept. 18, the central bank has lowered the federal funds rate, the interest rate that commercial banks charge each other on overnight loans, by a combined 1 percentage point.

As a result of the latest action, commercial banks' prime lending rate, the benchmark for millions of consumer and business loans, will drop by a corresponding amount to 7.25 percent, once again giving borrowers some breathing room.

Meanwhile, the Fed cut its discount rate, the interest it charges to make direct loans to banks, by a quarter percentage point as well to 4.75 percent on Tuesday.

The reduction in discount rate was aimed at encouraging banks to borrow more freely from the central bank at a time when there are worries that rising bad loans will prompt banks to tighten credit conditions too severely.

After cutting the federal funds rate by a half-point on Sept. 11 and a quarter-point on Oct. 31, the Fed hinted that those two reductions might be enough to stabilize the financial markets and beat back the threat of a recession.

Credit has become harder to obtain, however, while market turbulence increased and the housing slump has intensified. Fears of a recession are growing.

In a brief statement announcing the third rate reduction, the Fed said that "incoming information suggests that economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending."

Moreover, strains in financial markets have increased in recent weeks, added the statement.

The Fed hoped that the latest action, combined with the policy actions taken earlier, should help promote moderate growth over time.

"Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation," the statement said.

It vowed that the central bank will continue to assess the effects of financial and other developments on economic prospects and will "act as needed" to foster price stability and sustainable economic growth.

The Fed vote for the rate cut was 9 to 1 with Eric S. Rosengren dissenting, arguing for a bigger, half-point cut in the funds rate.

About inflation, the statement said that "readings on core inflation have improved modestly this year, but elevated energy and commodity prices, among other factors, may put upward pressure on inflation."

In this context, the Fed judges that "some inflation risks remain," and it will continue to monitor inflation developments carefully.

The latest rate cut came even as the economic growth rate accelerated in the third quarter.

The Commerce Department's revised data showed that the U.S. economy expanded at an annual rate of 4.9 percent in the July-to-September period, the fastest pace in the past 4 years.

The gain in gross domestic product was up from a 3.8 percent pace recorded in the second quarter and exceeded the 3.9 percent growth rate estimated originally.

However, the overriding worry for the Fed is that the housing slump, the worst in two decades, and tightening credit could seriously crimp spending and investing by people and businesses, dealing a dangerous blow to the economy.

The Fed on Nov. 20 slashed its forecast for the nation's economic growth to a range of 1.8 to 2.5 percent in 2008 from the 2.5 percent to 2.75 percent pace it forecast previously.

"These revisions to the 2008 outlook since June stemmed from a number of factors, including the tightened terms and reduced availability of subprime and jumbo mortgages, weaker-than-expected housing data, and rising oil prices," the central bank explained in its first quarterly economic forecast report under a new policy.
Many economists expect the economic growth pace to slow significantly to just 1.5 percent or even less in the final quarter of this year. They believe that the deepening housing slump and persisting credit crunch have raised the risks of a recession.