Citing dwindling threats of inflation, the Federal Reserve sliced a key short-term interest rate on Tuesday. Commercial banks were expected to follow suit with lower rates of their own.

The central bank policymakers, meeting in Washington, lowered their target for the federal funds rate to 5.5% from 5.75%, its level since July. The discount rate remained unchanged, at 5.25%.

The financial markets, which had begun to doubt the Fed would act on rates until January, rallied on the news. Many bank stocks posted gains.

Banking industry analysts have been bracing for the rate move. Many view it as a mixed blessing, helping the economy but narrowing many banks' net interest margins.

The Fed outlined the move in its typically brief, muted style:

"Chairman Alan Greenspan announced today that the Federal Open Market Committee decided to decrease slightly the degree of pressure on (bank) reserve positions.

"Since the last easing of monetary policy in July, inflation has been somewhat more favorable than expected, and this result, along with an associated moderation in inflation expectations, warrants a modest easing in monetary conditions."

A sizable part of the investment community has been waiting for six months for the Fed to follow up on its small rate cut last July 6. Since then, bond market rates had declined so much that the yield on the 10-year Treasury note recently hovered near the funds rate.

The markets were thrown off the trail when Fed vice chairman Alan S. Blinder, who has leaned toward lower rates, cautioned that the much-watched Treasury yield curve did not necessarily offer a guide to Fed action.

Mr. Greenspan, seen as more hawkish on rates than Mr. Blinder, has offered few recent public clues about his thinking, but several economists said he had probably favored waiting another month.

The Fed cut the federal funds rate, which is the rate for overnight loans of bank reserves; it did not cut the discount rate.

Because one rate was changed and the other was not, despite such a sizable decline in market rates, Tuesday's rate cut was likely a compromise.

The Fed probably would have preferred to stay in the background during the continued feuding between President Clinton and Congress over federal budgetary priorities, some observers said.

On the other hand, the central bank does not like to take action during election years and thus may have wanted to get on with easing credit, as warranted by the economy.

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