The Federal Reserve cut U.S. interest rates by a hefty half-percentage point on Wednesday as part of an ongoing aggressive effort to halt a sharp slowdown in an economy hit by a housing slump and a credit crunch.The Fed's action takes the bellwether federal funds rate to 3 percent, the lowest since June 2005, and comes just eight days after the central bank slashed rates by three-quarters of a point.

The cumulative 1.25 percentage point reduction in the interbank overnight rate in less than two weeks ranks among the most abrupt rate-cutting sprees in the modern history of the U.S. central bank. "The Fed has clearly decided that pulling out all stops to stabilize financial markets represents its main priority," said Lena Komileva, an economist at Tullett Prebon in London. The vote to lower rates, which was widely expected, was not unanimous. Dallas Federal Reserve Bank President Richard Fisher dissented, preferring to hold borrowing costs steady.

U.S. stock markets initially rallied in response to the rate cut, but renewed credit crunch fears erased the gains by the close. The Dow Jones industrial average finished down 37 points at 12,442. The dollar also moved lower, as did prices for longer-dated U.S. bonds, which are sensitive to inflation.

VICIOUS CREDIT CYCLE

The Fed's action came on the heels of a government report showing that the economy grew at a weak 0.6 percent annual pace in the last three months of 2007 as consumers curbed spending and homebuilding plunged. Growth of 2.2 percent for all of 2007 marked the economy's weakest expansion in five years. At the same time, a report showing private-sector employers added three times as many jobs as expected in January and a report earlier this week showing a big rise in orders for U.S.-made durable goods pointed to some economic resilience.

With a burst of aggressive rate cuts, the Fed is displaying its predilection for taking preventive action to halt what might become a vicious cycle of tighter credit or financial market turmoil amplifying a slowdown in economic activity. "Financial markets remain under considerable stress, and credit has tightened further for some businesses and households," the Fed said. "Moreover, recent information indicates a deepening of the housing contraction as well as some softening in labor markets."

However, the central bank also repeated that it would be monitoring inflation developments carefully, even though it expects inflation to moderate in coming quarters. In August, rising defaults on U.S. subprime mortgages led to a seizing up of credit markets. While conditions have improved, aftershocks from the subprime mortgage crisis have continued and financial markets remain volatile. At the same time, the housing market continues to plummet. Sales of new single-family homes fell 4.7 percent in December to their lowest level since 1995, the government said on Monday. For all of 2007, sales were off a record 26 percent.

(Additional reporting by David Lawder in Washington and Jennifer Coogan in New York; Editing by Diane Craft)

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