Sept. 15 (Bloomberg) -- China cut interest rates for the first time in six years and allowed most banks to set aside smaller reserves as worsening credit-market turmoil and weakening export demand dim the outlook for economic growth.

The People's Bank of China reduced the one-year lending rate to 7.20 percent from 7.47 percent, effective tomorrow, and lowered the reserve ratio at the nation's smaller banks by 1 percentage point. The changes were in a statement on the central bank's Web site today.

Lehman Brothers Holdings Inc. filed for bankruptcy today and Merrill Lynch & Co. agreed to be sold, adding to evidence that the credit crisis is deepening and threatening the global economy. Cooling inflation has given China room to cut borrowing costs and protect jobs in the world's fourth-largest economy.

``Policy makers see the probability of a recession in the U.S. is higher now, so the outlook for Chinese exports has deteriorated,'' said Darius Kowalczyk, chief investment strategist at CFC Seymour Ltd. in Hong Kong. ``Policy makers have concluded that inflation is easing permanently.'' He was the only one of seven economists in a Sept. 13 Bloomberg survey to predict a rate cut this year or in the first quarter of 2009.

China's inflation was the weakest in 14 months in August, slowing to 4.9 percent, export growth cooled and industrial production grew by the least in six years, according to data released last week.

`Important Problems'

The rate cut is ``to help solve important problems in our economy for its continued stable and fast development,'' the central bank said in the statement.

China's economy expanded 10.1 percent in the three months to June 30 from a year earlier, the fourth straight quarter of slower growth. From July, policy makers dropped references to a ``tight'' monetary policy and put extra emphasis on sustaining the economic expansion.

``The economic slowdown in the U.S. could be more serious than previously anticipated,'' said Zhao Qingming, senior economist at China Construction Bank Corp. in Beijing. ``The impact on China could be harsher, making it harder to maintain the pace of economic growth.''

Lehman Brothers Holdings Inc., the fourth-largest U.S. investment bank, filed for bankruptcy after losing 94 percent of its market value this year. Bank of America Corp. agreed to acquire Merrill Lynch & Co. for about $50 billion as the credit crisis claimed another of America's oldest financial companies.

Federal Reserve Acts

The Federal Reserve widened the collateral it accepts for loans to securities firms and boosted its program for lending Treasuries to bond dealers by $25 billion, bringing it to $200 billion. At the same time, a group of 10 banks that includes JPMorgan Chase & Co., Goldman Sachs Group Inc. and Citigroup Inc. formed a $70 billion fund to ensure market liquidity.

China's central bank had pushed the reserve requirement for banks to a record 17.5 percent in June. The nation's biggest banks were excluded from the reduction announced today.

Those exempted were: Bank of China Ltd., Industrial and Commercial Bank of China, Agricultural Bank of China, China Construction Bank Corp., Bank of Communications Co. and Postal Savings Bank of China.

The requirement for smaller banks drops by 1 percentage point from Sept. 25. For lenders in earthquake-affected areas, the reduction is 2 percentage points.

The central bank left deposit rates unchanged.

``Obviously this is negative for the yuan,'' said Kowalczyk. ``The yuan has benefited a lot from the widening of the interest rate differential between the U.S. and China.''

-- With reporting by Chua Kong Ho in Shanghai and Patricia Kuo in Hong Kong. Editors: Paul Panckhurst, Michael Dwyer

To contact the reporters on this story: Li Yanping in Beijing at yli16@bloomberg.net Kevin Hamlin in Beijing on khamlin@bloomberg.net

Last Updated: September 15, 2008 06:55 EDT