The aim is to energize consumer spending and business investment and help the economy snap out of a funk.
Fed Chairman Alan Greenspan and his Federal Open Market Committee colleagues reduced the federal funds rate from 1.25 percent to 1 percent, the lowest level since 1958.
The funds rate - the interest banks charge each other on overnight loans - is the Fed's main lever for influencing the economy.
The vote was 11-1 with Fed member Robert Parry dissenting. He favored a larger, half-point reduction in the funds rate.
The action marks the first reduction to the funds rate since November and the 13th since January 2001, when the Fed embarked on an aggressive rate-cutting campaign to rescue the economy from a developing recession and the fallout from the Sept. 11 terror attacks.
With the lowering of the funds rate on Wednesday, commercial banks were expected to cut their prime lending rates - the benchmark for many consumer and small-business loans - by a similiar quarter point, from the current rate of 4.25 percent to 4 percent, the lowest level since May 15, 1959
"The economy ... has yet to exhibit sustainable growth," the Fed said in a statement.
The Fed's next meeting is Aug. 12.
Economists say a reduction in the funds rate also helps ward off the economically dangerous threat of deflation, a widespread decline in prices, something that could emerge from a stagnant economy.
Although Greenspan and his colleagues say the chance of deflation is remote, the central bank still must be alert because of deflation's potential to wreck the economy, analysts say. Fed policy-makers raised the specter of deflation at their last meeting on May 6.
The United States' last serious deflation occurred during the Great Depression. A bad case of deflation can lead not only to widespread price declines, from goods and services to real-estate and stocks, but also to job losses and pay cuts.
Wednesday's rate cut comes as the economy struggles to get back on firmer footing.
The quick, postwar economic boom that some economists had hoped for hasn't materialized. For the most part, businesses have been reluctant to ramp up capital spending and hiring, major factors holding back the economy's ability to return to full health.
Consumers, meanwhile, have been the main force keeping the economy afloat. Even they, however, have been more inclined to spend cautiously than to splurge amid the muddled economic climate and sluggish job market.
The economy grew at a mediocre 1.9 percent annual rate in the first three months of 2003. Economists don't believe the economy fared much better in the current April-June quarter and may have done worse. Forecasts of the second-quarter economic growth rate range from 1 percent to more than 2 percent.
The latest batch of economic reports released Wednesday morning highlighted the split personality of the economy's uneven recovery. Manufacturers saw demand for their products drop in May for the second straight month, while home sales soared, stoked by super low mortgage rates.
Still, economists are hopeful the economy will pick up more speed in the second half of this year, with some predicting a growth rate of around 4 percent. A new round of tax cuts signed into law by President Bush last month should help on that front, analysts say.
Even so, economists aren't expecting a quick turnaround in the job market. The nation's unemployment rate climbed to a nine-year high of 6.1 percent in May as businesses cut 17,000 jobs. Depending on the strength of economic growth in coming quarters, the jobless rate could hover in that range or move higher, economists say.