NEW YORK (CNN/Money) - The Federal Reserve cut its key short-term interest rate Wednesday by a quarter-percentage point to the lowest level in 45 years, expressing worry that the economy still isn't strong enough to fight off deflation.

But the cut was smaller than some market participants expected, causing a selloff in stocks and bonds -- and some economists worried it could mean long-term interest rates have already seen their lowest lows.

Central bank policy-makers, at the end of a two-day meeting, cut their target for the federal funds rate, an overnight bank lending rate, to 1 percent, a rate not seen consistently since 1958.

In the statement accompanying its decision, closely watched by financial market participants for clues about the future of Fed policy, the Fed said it expects economic growth to strengthen in the near future but it was worried about a dangerous "substantial fall" in already-low inflation.

"The economy ... has yet to exhibit sustainable growth," the statement said. "With inflationary expectations subdued, [policy-makers] judged that a slightly more expansive monetary policy would add further support for an economy which it expects to improve over time."

In an unusual development, the decision to cut rates was not unanimous -- Robert Parry, president of the San Francisco Fed, wanted a more-aggressive half-percentage-point cut.

It was the first dissent at the Fed since September 2002, when the Fed decided to leave rates alone though two policy-makers wanted a rate cut. They got their way at the next policy meeting, in November, when the Fed cut rates by half a percentage point.

U.S. stocks were mixed after the news, while Treasury bond prices fell and the dollar recovered some ground. Markets were widely expecting a rate cut but were uncertain about the size of the cut or the language of the Fed's statement.

The Fed's statement, combined with a less-aggressive rate cut, was likely designed to keep markets from panicking about the state of the economy while also leaving the door open for future rate cuts.

"Today's Fed rate cut and directive clearly reflects the fact that the Fed is coming to the end of its rainbow and therefore wants to ensure that it still can convince financial markets that it still has further flexibility to do more if it needs to," said Anthony Chan, chief economist at Banc One Investment Advisors.

Some economists, however, were disappointed, believing a larger cut would have done more to sink long-term bond rates, which are critical to mortgage and corporate borrowing rates.

While many market participants might have interpreted a half-percentage-point rate cut as the end of the Fed's rate-cutting campaign, the likelihood of the Fed resorting to "unconventional" measures, such as buying longer-term Treasury bonds, would have increased.

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Anticipation of such moves would have caused traders to buy those bonds at signs of economic weakness, driving those rates lower, since rates and price move in opposite directions. Instead, the Fed seemed to signal that, if it were pushed to make another move, it would stick with conventional monetary policy.

"The tone of the statement, which I read as being surprisingly upbeat, considering everything we've heard, seemed to indicate that the whole idea that they might buy [longer-term bonds] is off the table," said Joel Naroff, president and chief economist at Naroff Economic Advisors in Holland, Pa. "Unless we have real signs the economy is faltering, we may have already seen the bottom in mid-to-long-term rates."

Wednesday afternoon's selloff in bonds seemed to demonstrate this, raising the possibility that mortgage rates, which have helped support a hot housing market and consumer spending, were unlikely to fall much more, if at all.

"From a fixed-income point of view, which I'm looking at, it's a little bit disappointing," said Anthony Hsieh, founder and CEO of HomeLoanCenter.com, an online mortgage lender. "We have seen the bottom on longer-term rates; everybody is assuming this may be the end of this party."

Bank prime lending rates, at least, were certain to fall -- many banks use the fed funds rate as a basis for their prime rates and were expected to announce cuts in those rates later Wednesday.

The Fed cuts rates to lower the cost of borrowing, pumping more money into the economy when it thinks activity is too slow. When inflation is a risk, the Fed raises rates.

The Fed has cut rates 13 times since the start of 2001, helping to fight off the effects of a recession, terrorist attacks, corporate scandals, war and more.

Most economists -- including Fed Chairman Alan Greenspan -- believe the economy will strengthen in the second half of the year. But some Fed officials have expressed concern that the economy might not grow fast enough to cause inflation to rise.

Though the Fed spent decades battling inflation, and falling prices are certainly good in the short run for consumers, further falling inflation -- or "disinflation," in Fed-speak -- could help set the stage for the nasty economic condition known as deflation.

The Federal Reserve cut its key short-term interest rate by a quarter-percentage point. CNNfn's Kathleen Hays reports. Play video (Real or Windows Media)

Japan, the world's second-largest economy, has battled deflation for much of the past decade, with little success. Deflation is an unstoppable drop in prices that hurts corporate profits, leading to more layoffs, which saps demand, hurting prices even further. It's a grim scenario the Fed has said it will do everything in its power to avoid.

It was unclear, however, if Wednesday's move would be enough to fend off deflation, or to get the economy going much faster.

"This cut ... won't do much good to perk up economic growth," said Sung Won Sohn, chief economist at Wells Fargo & Co. "Now, bond yields should be trending up. The Achilles' heel of the economy, business spending, won't be affected much by this cut."