Federal Reserve chairman Alan Greenspan and his colleagues cut the federal funds target rate, which commercial banks charge each other for overnight loans, to the lowest level since 1958.
It was the 13th cut since January 2001 and was aimed to boost a tentative recovery even as rock-bottom mortgage rates powered record new home sales.
Though the risk of weak prices in the postwar economy was "minor", it overwhelmed any risk of inflation, policymakers said.
The rest of the economy appeared to be turning in the right direction, but it could still do with a boost, they said.
"Recent signs point to a firming in spending, markedly improved financial conditions, and labour and product markets that are stabilizing. The economy, nonetheless, has yet to exhibit sustainable growth," the Federal Open Market Committee said in a statement.
"With inflationary expectations subdued, the committee judged that a slightly more expansive monetary policy would add further support for an economy which it expects to improve over time."
The decision passed by 11 votes to one, with San Francisco Federal Reserve president Robert Parry calling instead for a bigger cut of half a percentage point.
Low interest rates and improving productivity were boosting the economy, policymakers said.
"The committee perceives that the upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal," they said.
Data showing a red-hot housing market were balanced by a drop in large orders for US factories, providing further evidence of the US economy's uneven performance since the Iraq war, analysts said.
US new home sales soared 12.5 percent to a record-high annualized pace of 1.16 million in May, the government said.
For existing homes, meanwhile, sales surged 1.2 percent to an annual rate of 5.92 million homes in May, the third-largest total on record, according to the National Association of Realtors.
But new orders to factories for items such as planes, cars and washing machines dropped 0.3 percent to 168.3 billion dollars, compounding a 2.4 percent slump in April.
"The new home market is simply in another world, and that is helping keep shelter-related industries going. But with residential construction and sales so strong, you would think that the manufacturing sector, or at least segments of it, would be solid," said Joel Naroff, president of Naroff Economic Advisors.
"It is an indication of how weak manufacturing really is, that in spite of soaring housing activity, the sector is still faltering. When you look at it that way … you have to be concerned," Naroff said.
"That is, housing is doing its part, but that is the only part pulling its weight."