The U.S. Federal Reserve has cut the country's federal funds interest rate by three-quarters of a percentage point to a target range of zero to 0.25 per cent.

That is the lowest level on record in the United States for the rate, which is the price that banks charge each other for loans. U.S. commercial banks are now expected to lower the prime rate, the key rate for many loans to consumers. It's currently four per cent.

The cut sparked jumps in stock markets and a drop in the U.S. dollar against other currencies.

In announcing the cut Tuesday, the Fed said U.S. labour and market conditions, consumer spending, business investment and industrial production are all falling.

"Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further."

The economy is so bad that the rock-bottom rate is likely to continue for some time, the central bank said.

It also promised to use "all available tools" to get the U.S. economy moving. As it said previously, it will buy large quantities of debt and mortgage-backed securities to support to the mortgage and housing markets.

It's also considering buying longer-term bonds to push down long-term interest rates.

Stock markets make move

The Fed move prompted a surge in stock markets. In New York, the Dow Jones industrial average surged 4.2 per cent, gaining 359.61 points to 8,924.14. It had been up less than 100 points before the announcement.

The S&P/TSX composite index rose 3.1 per cent, adding 262.28 points to 8,724.11.

The U.S. dollar fell against other currencies, including the loonie, which closed up 2.02 cents at 83.21 cents US.

While the Fed was worried about inflation earlier this year, those concerns have eased with falling commodity prices and the economy's weaker prospects.

The U.S. Labour Department reported that inflation in November fell a record 1.7 per cent, the biggest drop since seasonally adjusted statistics were introduced in 1947. The drop in oil prices drove the decline.

Some economists believe the Fed's cut was affected by the inflation figure, because the prospect of deflation poses a profound threat to the economy.

The Fed cut was announced by its monetary policy committee after a two-day meeting to consider its response to what some are calling the worst U.S. economic conditions since the 1930s.

Many economists believed the Fed would cut interest rates in half on Tuesday to 0.5 per cent to spur the economy, but some wanted a more aggressive 0.75 percentage point cut.

Last week, the Bank of Canada cut its overnight rate by three-quarters of a percentage point, bringing it down to 1.5 per cent, a 50-year low.