US Federal Reserve policy-makers are worried that the credit crunch could sharply slow down economic growth, which would require big interest rate cuts, the minutes of the Fed's 11 December policy meeting, released on Wednesday 2 January, reveal.

But Fed officials are not discounting the possibility that financial market conditions could improve more rapidly than expected, which means it would be feasible to raise borrowing costs, reversing any cuts made in the interregnum.

Policy-makers weighed the impact of cumulative interest rate cuts, and a strong labour market, which suggested that the economy retained some forward momentum.

''Some members noted the risk of an unfavourable feedback loop in which credit market conditions restrained economic growth further, leading to additional tightening of credit; such an adverse development could require a substantial further easing of policy,'' the minutes of the meeting said.

At the same time, the minutes observe: ''Although members agreed that the stance of policy should be eased, they also recognised that that the situation was quite fluid and the economic outlook unusually uncertain.'' Risks to growth had risen since their previous meeting in large part due to deteriorating credit markets, the minutes said.

Overnight inter-bank borrowing costs were at 5.25 per cent when the Fed began cutting borrowing rates with a hefty half per cent cut in September, followed by quarter percentage point cuts in October and December, bringing the rate to 4.25 per cent. Boston Fed president Eric Rosengren dissented, preferring a more aggressive rate cut.

Coming just after Institute of Supply Management (ISM) data showed that the US factory sector contracted in December (See: Wall Street off to worst New Year start in 25 years), suggesting the possibility of recession had plunged stocks to unprecedented lows, the minutes, which signalled the possibility of more rate cuts, caused a bounce. But the Dow Jones industrial average still closed down 220 points, or 1.7 per cent for the day, and bond prices surged.

Analysts are interpreting the Fed minutes as indications that there will be additional rate cuts, or other measures to lower rates, sooner rather than later. The minutes show that policy-makers are increasingly concerned that signs of economic softening coupled with credit market strains are a risk to the economic expansion.

The Fed staff also revised down their estimate for growth in the final months of 2007, and projected the economy to expand at a rate ''noticeably below its potential'' in 2008. ''Growth in late 2007 and during 2008 was likely to be somewhat more sluggish than participants had indicated in their October projections,'' the minutes said.

The housing correction was likely to be deeper and more prolonged than anticipated, Fed officials agreed at the meeting. Officials took note of a ''marked deceleration'' in consumer spending.

The government's report on the December employment situation, due on Friday 4 January, will give important clues about the real state of the economy.

The December federal funds rate cut disappointed Wall Street hopes for bolder action. But, the Fed also trimmed the discount rate it charges for direct loans to banks by a quarter point. Market participants were dissatisfied with this too, but the very next day the Fed and central banks around the world banded together to announce a series of steps to ease credit market strains.

As part of that effort, the Fed has auctioned $40 billion in funds and is due to hold two more auctions in January. It has said it would continue auctions as necessary to break logjams in credit markets. This has helped ease credit markets, as evidenced by lower London inter-bank offered rates (LIBOR), a common benchmark for adjustable rate mortgages.

But the US economy still appears to be on shaky ground and many analysts have said recession risks have risen in recent weeks. Financial markets expect the Fed to cut interest rates by at least a quarter (if not a half) percentage point at its next policy meeting on 29 and 30 January, after Wednesday's ISM report showed that factory activity contracted in December.

In another worrisome sign, US crude oil prices hit a record high of $100 a barrel for the first time on Wednesday. On 11 December, Fed officials had said inflation readings were less favourable than they had been in the past, but anticipated an easing of core inflation, which mainly depends on food and energy.