The move came barely an hour after the announcement that the country's jobless rate jumped last month to an eight-year high of 7.8 per cent.
The unemployment figures were far worse than Wall Street economists had forecast - and the rate cut bigger than expected.
The dollar dropped by around two pfennigs, but found buyers as it reached the psychological barrier of DM1.50. After rebounding, it closed just 0.25 pfennigs down on the day in London at DM1.5130. The pound gained 0.43 cents to end the day at dollars 1.9170, its highest level since spring last year.
Trade among the European currencies was sidelined as attention focused on the roller-coasting dollar. The pound gained a fifth of a pfennig to climb back above DM2.90, although it remained the weakest currency in the ERM.
The rise in unemployment, which follows a crop of poor US economic indicators in recent days, is the most pressing signal yet that the modest recovery which began anew in the first quarter of 1992 may be about to peter out once more - at the worst possible moment for President Bush in his uphill struggle for re-election in November.
Yesterday Mr Bush, who twice last week publicly demanded a cut in interest rates, tried to minimise the impact of the latest developments. The recovery had continued in the second quarter, albeit 'not as robustly as I'd like to see it', he maintained, insisting that unemployment was traditionally a 'lagging' indicator. But he conceded in a grim-faced appearance with Republican congressional leaders: 'This is not good news.'
June's increase in unemployment, from 7.5 per cent in May, means the number of those registered as seeking work has risen 0.6 per cent in just two months. Detailed figures offer no solace either - contrary to analysts' expectations, non-farm employment declined last month by 117,000. 'This is simply a disaster,' one bank economist said.
Nor is there any prospect of an early reversal of the trend. The housing market is flat, while the Commerce Department separately reported yesterday that factory orders dropped 0.8 per cent in May, their first decline in five months.
The overall picture uncannily resembles 12 months ago, when a brief summer upturn after the Gulf war fizzled out in the autumn.
Previously the Fed had maintained that further interest rate cuts were unnecessary and might only rekindle inflation. But the barrage of bad tidings left it little choice but to comply with Mr Bush's urgings. The reduction brings the discount rate down to a level last seen under President John Kennedy.
Leading commercial banks, led by Citibank and Morgan Guaranty, took the hint at once, cutting prime rates by half a point to 6 per cent, the lowest level since 1973. Long-term bond prices soared, reducing the yield on benchmark 30-year Treasury bonds to 7.63 per cent.
The Fed also added temporary liquidity to the banking system, signalling a half-point cut in its target for the rates at which banks lend to each other. This took the Federal funds rate target to 3.25 per cent.
Economists said interest rates might have further still to fall. 'Another quarter-point cut in the Fed funds rate is certainly not out of the question', said Angus Armstrong, of Morgan Grenfell. However, Steve Barrow, of Chemical Bank, said the Fed might have moved early to avoid a politically contentious cut closer to November's presidential election.
Spurred by the news on unemployment, Congress is moving swiftly to vote an extension of benefits for those who have exhausted their coverage by a further 26 weeks.
Previous extensions have been bitterly contested by Mr Bush on the grounds of cost. This time, however, fears of incurring extra election year unpopularity might prevent a White House veto.
Meanwhile, congressional and White House negotiators have agreed on a compromise urban aid package in the wake of the Los Angeles riots.
The plan involves capital gains tax cuts to encourage enterprise zones in the inner cities and dollars 2.5bn of other spending, spread over five years.Reuse content