The Fed said it was cutting the federal funds rate, the interest that banks charge each other on overnight loans, to 3.5 percent, down by three-fourths of a percentage point from 4.25 percent. It said it had taken the action in view of a weakening economic outlook and increasing downside risks to growth. "While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households," it said in a statement.
"Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labour markets."
It promised to act in a "timely" manner if needed.
The cut follows steep stock market sell-offs around the world. The US markets had been closed yesterday for the Martin Luther King day holiday.
The index of leading shares was down 26.5 points at 5,551.7 in the opening session. Yesterday it plunged 5.5%, the biggest fall since 9/11.
The Federal Open Market Committee had been due to convene next week, but brought its meeting forward after stock markets plunged in Europe and Asia yesterday, when Wall Street was closed for a holiday.
Today's cut is bigger than any single intervention during the 1987 stock market crisis. It is the biggest reduction since 1984 when interest rates were chopped by 175 basis points.