In a dramatic bid to shore up the US economy, the Federal Reserve on Tuesday slashed its benchmark interest rate by three quarters of a percentage point to 3.5 per cent, and hinted that more cuts may be coming.

Still, recession fears and a worldwide sell-off caused US stocks to plunge when Wall Street opened for the day before concerns appeared to ease, mitigating the markets' decline. The Dow Jones Industrial Average lost more than 400 points in early trading, while stocks in Europe reversed earlier gains.

But by later in the day market losses were less severe, with the Dow Jones Average down 1.2 per cent, or 147.21 points, at 2 pm (1900 GMT). The Standard & Poor's 500 Index was down 17.86 points, or 1.4 per cent, and the technology heavy Nasdaq Composite Index had fallen 47.48 points, or 2 per cent.

The Fed's action came two days into a selloff on global markets, fed by concern over a US housing-market slump, the subprime mortgage crisis and high oil prices. An economic stimulus plan unveiled by President George W Bush last week has failed to impress investors.

The Fed lowered the federal funds rate "in view of a weakening of the economic outlook and increasing downside risks to growth," a statement by the central bank's policy-making committee said.

The announcement came before Wall Street reopened for the week and a week ahead of the Fed's next scheduled meeting on January 29-30, where analysts had expected a cut of half a percentage point. Wall Street was closed Monday for a federal holiday.

But the decision also bared concern that the Fed may be panicking under market pressure. One of the 10 Federal Open Market Committee members voted against Tuesday's cut, saying action could have waited until next week's regular meeting.

Fed policymakers will continue to monitor risks to the economy and "will act in a timely manner as needed to address those risks," the statement said.

Financial markets have broadly "continued to deteriorate and credit has tightened further for some businesses and households," the Fed said. It also pointed to a deepening US real-estate slump and a spike in unemployment in December.

Bush on Friday proposed about 140 billion dollars in tax relief for US individuals and businesses in an effort to boost consumer spending, the US economy's driving force.

Bush met with his top economic advisors Tuesday morning to discuss the economic stimulus plan and the market turmoil, White House spokesman Dana Perino said.

Perino said Bush's advisors will work with Congress to hash out the details of a package that would not rule out the possibility of a larger tax cut.

"What the president wants is to make sure that we do something quickly enough so that we can have an impact this year," Perino said.

Treasury Secretary Henry Paulson described the Fed actions as "constructive."

"It shows to this country and the rest of the world is that our central bank is nimble and is able to move quickly to respond to market conditions," he said. "And I think that should be a confidence builder."

Congress welcomed the Fed's move. Speaker of the House Nancy Pelosi said it showed "a commitment across all levels of government to revitalize the economy, restore confidence in the markets, and help Americans struggling with soaring bills for gasoline, groceries, housing and home heating."

She added that Congress would work to quickly develop a stimulus package with the Bush administration.

The cut in the federal funds rate was the Fed's sharpest since a 1980-81 US recession. Fed policymakers also lowered the discount rate to 4 per cent from 4.75 per cent.