Fed sees rates near zero for extended period

As expected, the Fed kept its benchmark federal funds rate unchanged in a range of zero to 0.25 percent, and said the economy had "continued to pick up" since its last policy-setting meeting in September.

The Fed, the U.S. central bank, also said it would buy about $175 billion of debt issued by government-backed mortgage finance agencies, less than the $200 billion maximum it had originally allotted, citing limited availability.

In its closely watched policy statement, the Fed said household spending "appears to be expanding but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit."

That was somewhat more upbeat than September's statement, which referred to spending as "stabilizing."

The central bank, wary of undercutting the fragile recovery by withdrawing its support too soon, is also on guard for any indication that its emergency lending efforts are fueling an unwelcome bout of inflation as the economy heals.

But top Fed officials, including Chairman Ben Bernanke, have said the U.S. recession, the most painful since the 1930s, has left a legacy of high unemployment and idle factories that should keep price pressures in check.

A private report on Wednesday showing U.S. companies cut payrolls at the slowest pace in more than a year may add to a sense that the economic numbers are moving in the right direction.

However, while the government on Friday is expected to report that the drop in employment is abating, the jobless rate is forecast to rise to a fresh 26-year high of 9.9 percent.

The world's largest economy grew at a faster-than-expected 3.5 percent annual rate in the third quarter, which effectively signaled the end of the downturn.

Suggesting further momentum, data on Monday showed manufacturing activity hit its highest level in 3-1/2 years last month, though a report on Wednesday showed the nation's vast services sector was growing only modestly.

In an act demonstrating confidence in the economy's prospects, billionaire investor Warren Buffett on Tuesday said his company, Berkshire Hathaway Inc, agreed to purchase the nation's largest rail company, saying it is poised to benefit from the recovery.

While the outlook has improved, many economists still expect the recovery to be sluggish and in need of the Fed's easy-money policies for a while longer.

Unemployment is expected to climb into next year, damping consumer spending, which accounts for around 70 percent of U.S. output. The banking system is still under pressure from loan losses, and credit remains tight.

Most analysts at top U.S. banks have been expecting the Fed to keep interest rates on hold until mid-2010 or later.

Even before it raises rates, the central bank is expected to begin to withdraw some of the enormous amounts of cash it pumped into the economy after chopping rates to near zero. That withdrawal of liquidity from the financial system is seen as key to containing inflation risks.

Other central banks are also wrestling with how best to spur growth and when to withdraw extraordinary measures to support their economies.

The European Central Bank is expected to keep rates on hold at a record-low 1 percent on Thursday, while there is a good chance the Bank of England will expand its large asset purchase program at a meeting the same day.

(Additional reporting by Pedro Nicolaci da Costa, David Lawder and Emily Kaiser; writing by Mark Felsenthal and Emily Kaiser)