The federal funds rate was lowered 25 basis points to 3.5 percent, a seven-year low. In a statement, the Fed said it remains concerned about the sluggish U.S. economy.
The Fed also lowered the discount rate, the interest rate it charges banks to borrow, by 25 basis points to 3 percent. The funds rate is the interest on loans that banks can charge each other to borrow.
After trading higher for most of the day, both the Nasdaq composite index and the Dow Jones industrial average headed lower after the announcement.
"What we really wanted to hear is some body language saying that things are starting to firm up," said Todd Clark, co-head of trading at WR Hambrecht.
In its announcement, the Federal Reserve included a short list of troubling economic signs, such as the dismal earnings performance from corporate America and slower economic growth.
"Business profits and capital spending continue to weaken and growth abroad is slowing, weighing on the U.S. economy," the Fed said in its statement.
The Fed also noted some positive trends in the economy, saying demand from consumers has held up, and the shortage in the labor supply continues to ease.
In 1999 and 2000, the Fed raised the funds rate six times for a total increase of 1.75 percentage points to a high of 6.5 percent in May. It also raised the discount rate five times, to 6 percent, an increase of 1.5 percentage points.
However, recent economic data have indicated that the U.S. economy might be slowing too much. The Gross Domestic Product, the value of all U.S. goods and services, grew 1.9 percent in the fourth quarter of 2000 and 1.3 percent in the first quarter. Advance estimates put second-quarter growth at 0.7 percent.
The Fed started its assault Jan. 3 by calling an unscheduled meeting and has lowered rates each time since, including five 50-basis-point cuts.
The Federal Reserve's primary focus is to contain inflation, and its main instrument is interest rates. When it senses the economy is growing at a rate that could ignite inflation, it often raises rates, which raises the cost of borrowing money and can pinch corporate financial activity.
But when the economy seems headed for trouble, the Fed decreases rates. Lowering interest rates makes it less costly for businesses to finance expansion plans and increases the incentive to borrow money, which can spark economic growth. Lower rates can result in more stable stock prices, too, because interest-paying investments become less attractive.
The Federal Reserve's policy-making committee meets again Oct. 2.