The US stock market soared after the Fed took the unusual step of cutting rates in advance of its regular monthly meeting, citing "growing caution by lenders and unsettled conditions in the financial market". The Dow Jones Industrial Average closed up 330.58 points at 8,299.36.
Yesterday was the second time the Fed, led by chairman Alan Greenspan, has cut US interest rates in recent weeks. A fortnight ago it cut the US funds rate by 0.25 points, a move which was poorly received by the market, which hoped for a larger cut.
Last night, by contrast, the Fed's decision to trim the funds rate by a further quarter point to 5 per cent as well as to cut the discount rate by 0.25 points to 4.75 per cent took the markets by surprise. The rate cuts are expected to have positive effects in the London stock market today .
All eyes in the City will now be on the Bank of England's Monetary Policy Committee (MPC), which next meets to set UK interest rates in early November.
Earlier yesterday Eddie George, the Bank of England Governor, fanned speculation about further reductions in UK rates when he indicated that a weak pound would no longer be a barrier to rate cuts.
His comments, combined with evidence from the British Chambers of Commerce (BCC) of a marked services sector slowdown, sent sterling almost four pfennigs lower against the Deutschmark.
The Governor also said he agreed with Mr Greenspan that, given the fragile market environment, policymakers had to be particularly alert. Giving evidence to MPs on the Treasury Select Committee, Mr George welcomed recent falls in sterling. He said: "It is not enough for the sectors that are suffering, but it is a move in the right direction."
Previously Mr George and other MPC members had expressed concern that rate cuts would prompt a sharp fall in the pound, which, in turn, could generate inflationary pressure.
Rate cut speculation knocked the pound from DM2.803 on Wednesday evening to DM2.767 by close of trade yesterday.
Mr George told MPs that, despite media speculation, recent comments about the UK economy made by Chancellor Gordon Brown had not influenced the MPC in any way.
The Governor said the Chancellor had been "absolutely scrupulous" in his dealings with the bank. "He has had lots of opportunities to have a nudge, nudge, wink, wink, word in your ear. But he has not done that at all."