US Federal Reserve cuts interest rates

The US Federal Reserve's shock lowering of its discount rate has increased the prospect of a 100 basis point reduction of its federal funds rate this Tuesday, or possibly before, economists say.

Despite it being Sunday evening (US time), the US Federal Reserve announced in a statement its board had voted unanimously to cut the primary credit rate from 3.50 per cent to 3.25 per cent, effective immediately.

The move reduced the spread between the primary reserve rate, also known as the discount rate, and the federal funds rate to 25 basis points. The federal funds rate is to 3.0 per cent.

The US Federal Reserve's Federal Open Market Committee, meets on Tuesday (US time) and Commonwealth Bank chief currency strategist Richard Grace said a whole one percentage point cut was now on the cards.

"The Fed are likely to cut rates (Fed funds and discount rate) by up to 100 basis points on Tuesday to further provide a circuit-breaker for risk-averse markets," Mr Grace wrote today.

Mr Grace said the move on Sunday was "supportive" for the Australian dollar, particularly the Australian dollar against the yen.

"The initiatives taken by the Fed will ease risk aversion," he said.

The Fed also announced an initiative to improve the ability of US primary dealers to improve financing to participants, essentially a new lending facility to help banks secure short-term loans for the next six months, maybe longer.

The steps were "designed to bolster market liquidity and promote orderly market functioning," the Fed said in a statement.

"Liquid well-functioning markets are essential for the promotion of economic growth."

St George Bank senior market strategist Besa Deda said the Fed could cut rates even further before Tuesday's meeting.

"It obviously highlights the concern the Fed has about the risk to economic growth and also the Fed's focus in trying to bring about improved liquidity and stability to financial markets," Ms Deda said today.

"You can't rule them out cutting out the Fed funds rate even before they meet even though it is not that long away."

"Either way, they seem set to cut aggressively in the short term."

Ms Deda said a 100 basis point move lower was on the cards.

ICAP senior economist Matthew Johnson said the "highly unusual" move by the Fed on Sunday was designed to "decrease the cost of financing assets for banks, broadly speaking".

"It means that the spread between financing assets and lending cash is narrower," Mr Johnson said today.

Mr Johnson said another change, allowing primary dealers to borrow at the discount window, will open up that facility to entities such as Bear Stearns, which is being taken over by JP Morgan, to borrow at the discount rate.

Mr Johnson expects the Fed to cut both the Fed funds rate and the discount rate by 100 points at Tuesday's meeting.