Updated from 8:59 a.m. EDT

The Federal Reserve reduced the rate it charges banks who want to borrow from it, saying financial market conditions have deteriorated, and tighter credit and increased uncertainty have the potential to hinder economic growth.

By lowering the discount rate by 50 basis points Friday, rates will go to 5.75% from 6.25%.

With the cut, the spread between the primary credit rate and the Federal Open Market Committee's target federal funds rate is now 50 basis points. The fed funds rate, the rate banks use to charge each other interest on overnight loans, was unchanged at 5.25%.

Some investment banks, including Lehman Brothers ( LEH) and Goldman Sachs ( GS), are now expecting the Fed to lower the fed funds target.

The Fed has added billions of dollars in liquidity to the system in recent days, including $17 billion on Thursday, but it had yet to take any action on rates. Markets worldwide have slumped lately as worries about access to credit, stemming from a seize-up in the mortgage sector, have spread.

Names like Countrywide ( CFC), KKR Financial Holdings ( KFN) and Thornburg Mortgage ( TMA) are among the U.S. stocks that have been hit hard at least once this week as investors grew increasingly jittery about the companies' financial health.

Because of the current situation, "although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably."

The FOMC is the Fed's policymaking arm. It said it is "monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets."

For months, officials have been indicating the fed funds target probably wouldn't be cut as long as they felt economic numbers suggested the greatest threat was inflation, but many market participants have been hoping that stance would change amid the credit scare.

Additionally, the Fed announced a change to the Reserve Banks' usual practices to allow the provision of term financing for as long as 30 days, instead of overnight. The changes will remain in place until the Fed determines that market liquidity "has improved materially. These changes are designed to provide depositories with greater assurance about the cost and availability of funding."

The Fed said it will continue to accept a range of collateral for discount window loans, including home mortgages and related assets. Existing collateral margins will be maintained.

Following the move, stock futures recovered from early losses and were much higher.