By Mark Felsenthal and Alister Bull
WASHINGTON (Reuters) - The Federal Reserve on Wednesday upgraded its assessment of the U.S. economy, saying activity had picked up after a severe downturn, but renewed its pledge to keep rates exceptionally low for an extended period to support a fragile recovery.
The Fed also said it would slow purchases of mortgage debt to extend that program's life until the end of March, in a step toward a measured withdrawal of its extraordinary support for the economy during the downturn.
The U.S. central bank, as widely expected, held overnight lending rates at close to zero percent.
"Information received since the Federal Open Market Committee met in August suggests that economic activity has picked up following its severe downturn," the Fed said in a statement after its two-day policy meeting.
"Conditions in financial markets have improved further and activity in the housing sector has increased," it said.
U.S. government bond prices improved on the news that the central bank had reiterated a pledge to keep rates ultra-low for an extended period.
"I think it confirms that the economy still needs a little bit of help and that rates aren't going to go up anytime soon," said Alan Lancz at Alan B. Lancz & Associates in Toledo, Ohio.
The U.S. central bank also said inflation would remain subdued for some time due to substantial slack in the economy dampening cost pressures, and with stable long-term inflation expectations.
The Fed said it would gradually slow the pace of its purchases of mortgage-related debt in order to promote a smooth transition in markets.
But in a slight tweak of language in its statement, the Fed made clear it would purchase $1.25 trillion of agency mortgage-backed securities. In its August statement the Fed had said it would buy "up to" that amount, but dropped those two words in Wednesday's announcement.
The Fed doubled the size of its balance sheet to more than $2 trillion as it flooded financial markets with money during the crisis last year.
It has maintained this support through a campaign to buy $300 billion of longer-dated U.S. government bonds and $1.45 trillion of mortgage-related debt in an effort to keep lending rates low, including $200 billion of debt issued by government-backed mortgage finance agencies.
The Fed opted in August to taper down the Treasury purchases by the end of October, and had been expected to opt for a similar gradual withdrawal for its mortgage debt buying, which initially had been scheduled to close at year-end.
The U.S. central bank must walk a delicate path between acknowledging the recovery evident in the economy, and assuring investors that it remains tuned to the risks of a double dip recession as policy stimulus fades next year.
This means exiting in time from aggressive steps aimed at boosting growth to avoid igniting inflation as the economy picks up steam, while not smothering the recovery in the process.
Recent data has pointed to turnarounds in manufacturing, housing markets and consumer sentiment, and many analysts expect strong growth in the third quarter after four quarters of contraction. However, with unemployment at a 26-year high of 9.7 percent, most analysts nevertheless expect consumer spending to remain weak and damp the recovery.
(Reporting by Alister Bull, Mark Felsenthal and David Lawder; Editing by Andrea Ricci)
