The move, the first US rate cut in four years, is aimed at restoring confidence in the housing market and preventing the turmoil from denting the economy.

Other central banks, including the Bank of England, are expected to follow suit to calm the growing financial panic.

World stock markets soared on the news, with US shares up sharply.

The Fed move could help prevent the US economy, which is already slowing down, from sliding into a recession, which could hurt economic growth prospects around the world.

The tightening of credit conditions has the potential to intensify the housing (market) correction and to restrain economic growth more generally

US Federal Reserve

Q&A: What the rate cut means The Fed's statement in full

And at close the Dow Jones industrial average was up 2.51% at 13 739.39, the S&P 500 Index was up 2.92% at 1,519.78, and the Nasdaq was up 2.71% at 2,651.66.

It was the S&P 500's biggest percentage gain since March 2003, and Dow average's best one-day percentage gain since 2003.

'Economy fragile'

By making money cheaper to borrow, the central bank is hoping that people will spend and invest more, revitalising the economy,

By cutting rates the Fed would be boosting the US economy by making it cheaper to borrow money



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But the Fed faces a dilemma, with some commentators worried that too-big rate cuts could stoke up inflation.

A reduction in rates by 50 basis points would fuel inflation and lead to the "cheap money" conditions that have brought boom-and-bust to the property sector, they had argued.

But in a statement, the Fed said that they needed to act before the credit crunch caused more damage to the economy.

It said that "the tightening of credit conditions has the potential to intensify the housing (market) correction and to restrain economic growth more generally".

The size of the cut - the first time that the rate has changed in more than a year - took many analysts by surprise.

William Sullivan, chief economist at JVB Financial Group in Florida said: "It's difficult to interpret what the ultimate ramifications will be.

"The Fed's rate cut could suggest that the stresses in the credit markets are larger than what people thought and that the Fed thought an aggressive move was needed now."

And Tim Evans, an energy analyst at Citigroup Futures in New York, said: "This confirms that the US economy is fragile and attempts to avoid a full recession by cutting interest rates may or may not be successful, but this shows that the Fed is taking the possibility of a recession seriously."

Inflation figures

But there was better news for those concerned about inflation with the Producer Prices Index (PPI) for August showing a bigger than expected fall.

The Bureau of Labor Statistics said that the measure of the prices paid to producers of goods and services in the US fell by 1.4%, which was the biggest fall since October 2006.

"The August PPI was good news," said Gary Thayer, chief economist at AG Edwards and Sons in St. Louis.

"There was a decline in energy prices that helped pull the overall index down and core inflation looks relatively modest," he added.

'Won't deliver'

The Fed made its announcement after its one-day policy meeting.

It has coincided with the imminent release of third-quarter results from a string of investment banks.

The first of those results, from Lehman Brothers, came in better than expected, suggesting the banks have not been hit as hard as had been thought.

The Fed started raising rates from their historic low of 1% back in June 2004 to put the brakes on a US economy that was showing signs of overheating.

They had been on hold at 5.25% since mid-2006 after 17 consecutive rises.