U.S. Federal Reserve policymakers recognized at December’s meeting that their third-straight reduction in the central bank’s key lending rate might not be the last of the cycle amid continued erosion in credit and housing markets that has crept into consumer spending.

Some Fed members even saw the risk of a vicious cycle pulling down both financial markets and the economy that may require “substantial further easing of policy.”

Officials “agreed on the need to remain exceptionally alert to economic and financial developments and their effects on the outlook, and members would be prepared to adjust the stance of monetary policy if prospects for economic growth or inflation were to worsen,” according to the minutes of the Dec. 11 Federal Open Market Committee meeting, released today.

At that meeting, the FOMC voted 9-1 to lower the federal funds rate at which banks lend to each other by a quarter percentage point, to 4.25%, its third-straight reduction since September totaling one percentage point. Boston Federal Reserve Bank President Eric Rosengren dissented in favor of a half-point cut.

The Fed also lowered the discount rate it charges banks that borrow directly from the Fed by one-quarter point, to 4.75%.

According to the minutes, officials were caught off-guard by the extent of the housing slump, and “participants agreed that the housing correction was likely to be both deeper and more prolonged than they had anticipated in October.”

Meanwhile, financial-market strains “could persist for quite some time,” the minutes stated, though some officials saw the possibility that conditions could improve more quickly than anticipated, “in which case a reversal of some of the rate cuts might become appropriate.”

But the tone of the minutes suggest risks are weighted toward economic weakness, and not a quick rebound in economic activity that might lead to inflation. Indeed, Fed staff economists expect gross domestic product to expand “noticeably” below its potential in 2008.

Officials said that while inflation readings were “slightly less favorable” between the October and December FOMC meetings, they still expect core inflation, which excludes food and energy prices, to “trend down a bit over the next few years.”

Headline inflation, meanwhile, should slow “more substantially from its currently elevated level,” according to the FOMC minutes.