TORONTO (Reuters) - The Toronto Stock Exchange's main index plunged more than 200 points yesterday as investors who expected an aggressive US interest rate cut were disappointed by a more modest move and instability fears continued to weigh on the market.

The S&P/TSX composite index was down 216.65 points, or 1.55 percent, to close at 13,723.71.

The drop wiped out gains seen earlier in the session and came after the US Federal Reserve cut its key fed funds rate by 25 basis points to 4.25 percent.

The US central bank also reduced the discount rate it charges banks for direct loans by 25 basis points to 4.75 percent.

While most economists and many investors anticipated a quarter-point rate cut, some had called for a bolder reduction by the Fed of 50 basis points as the US copes with tight credit markets and a protracted housing slump.

However, those calling for a bigger cut were seen as being in the minority and the sell-off took some observers off guard.

"I'm just very surprised we're getting such a negative reaction," said Glenn MacNeill, vice-president of investments at Sentry Select Capital Corp.

"We've seen pretty rocky markets as fear seems to be dominating the package here," he said, adding he viewed the rate cut as "good news."

The S&P/TSX 60 index of Canadian bluechips fell 15.08 points, or 1.85 percent, to 798.95.

The sell-off in the resource-laden Toronto market was exacerbated by a sharp drop in the price of gold which also came in wake of the Fed move.

Nine of the TSX's 10 main subgroups moved lower, including the materials group which dove 2.92 percent.

Energy issues fell 1.62 percent and financials, sensitive to rate moves, gave up 1.15 percent.

A pair of mining companies were the session's two biggest net losers: First Quantum Minerals took the top spot, shedding C$4.67, or 4.8 percent, to C$92.70. Inmet Mining was second, falling C$4.13, or 4.6 percent, to C$84.98.

The nosedive that came in wake of the Fed rate announcement could have been caused by what the central bank chose to do regarding discount rates, suggested Neil Andrew, portfolio manager at Leeward Hedge Funds in Toronto.

"The Fed funds rate was one thing - everyone expected that quarter point - but on the discount rate, people wanted the 50 (basis points)," he said.

He called the market's reaction to the news a "knee-jerk" pullback and predicted it might not be long before buying resumes again.