Its decision to hold firm against a rate cut came as financial turmoil unleashed by the failure of Lehman Brothers and fuelled by the crisis at AIG convulsed global markets for a second day yesterday as money markets froze.

Some analysts speculated that the Fed could announce a back-to-back loan to the embattled insurer AIG via a third party bank, such as JP Morgan Chase, as a partial substitute for a rate cut in terms of calming market fear of sudden asset sales by the troubled insurance group.

Brutal conditions in European money markets yesterday morning, saw the overnight dollar borrowing rate briefly hit 10 per cent amid a desperate scramble for liquidity. Financial stocks came under severe strain as sentiment was depressed by AIG's deepening plight, a slump in the shares of HBOS, the UK's largest mortgage lender, and a damaging credit rating downgrade for Washington Mutual, the troubled US bank.