WASHINGTON — The Federal Reserve trimmed its key lending rate for the third time in a row Tuesday. But the quarter-point cut was smaller than many expected, indicating uncertainty at the central bank over how serious a threat the turmoil in the nation's financial markets poses to the economy.
Wall Street, anxious about mounting mortgage-related losses in the banking system, was disappointed by the size of the Fed's move. Stocks suffered their worst one-day drop in more than a month, with the Dow Jones industrials falling nearly 300 points.
The central bank's rate-setting Federal Open Market Committee trimmed the target for the federal funds rate, which banks charge one another for overnight loans, to 4.25% from 4.5%. The Fed has now cut that rate a full percentage point since it began its current round of reductions in September.
The Fed also reduced its discount rate, the price it charges for loans it makes directly to banks, by a quarter of a point, to 4.75% from 5%.
Banks responded to the cut in the federal funds rate by lowering their prime rate, a benchmark for many business and consumer loans, by a quarter of a point to 7.25%.
Many analysts had predicted that the Fed would cut both rates by half a point, and they expressed dismay at the central bank's decision.
"It was not as forceful as it should have been, and their statement wasn't as forceful as it should have been," said David Jones, chairman of Investors Security Trust in Fort Myers, Fla. "They should have said they would do what it will take to deal with the credit crisis."
By late afternoon, Fed officials were hinting to news organizations that they were prepared to take further steps to calm the banking system, perhaps by quickly making another cut in the discount rate.
The problem is that Fed officials can't seem to agree on how much they can do about the credit crunch created by the sub-prime mortgage crisis, analysts said. Some portrayed the cuts Tuesday as an uncomfortable compromise between two camps: one favoring a half-point reduction, the other preferring to hold rates steady.
"I think there was a fight between those who wanted to pause and not do anything, keep policy unchanged, and those who wanted to cut," Jones said.
"What's showing is the debate within the Fed," said Diane C. Swonk, chief economist with Mesirow Financial in Chicago.
