Fed cautious on recovery and sticks to bond plan

A man looks over employment opportunities at a jobs center in San Francisco, California, in this February 4, 2010 file photo.

WASHINGTON (Reuters) - The Federal Reserve on Tuesday offered only a cautious nod to the economy's improving prospects as it put a spotlight on lofty unemployment and reaffirmed its commitment to buy $600 billion in bonds.

In a statement that emphasized job market weakness and low inflation, the Fed characterized the U.S. expansion as "continuing," a modest upgrade from its November description of the recovery as "slow."

"The economic recovery is continuing, though at a rate that has been insufficient to bring down unemployment," the Fed said in a statement at the conclusion of a one-day meeting.

The sober assessment stood in contrast to increasingly optimistic forecasts on Wall Street, where analysts have been revising economic projections based on a slew of stronger-than-expected data and a new government tax cut plan.

As widely expected, the Fed offered no policy shift. It held overnight interest rates near zero, repeated a vow to keep rates exceptionally low for an extended period and renewed its pledge to buy about $75 billion worth of bonds a month to hold down long-term interest rates.

"What I think the Fed is trying to do is kick the can, so to speak, until their January 2011 meeting," said Joe Kinahan, chief derivatives strategist at TD Ameritrade in Chicago.

The dollar edged up against the euro and the yen as the Fed offered no sign of expanding its bond buying, but Treasury bonds extended losses on the central bank's dovish remarks.

On Wall Street, stocks were little changed after the statement and ended the day modestly higher.

GLOOMY OUTLOOK, DEFLATION CONCERNS

While offering a tempered acknowledgment of the apparent strengthening in the economy, the Fed maintained its focus on the two principle areas it is trying address: high unemployment and a slowing in already low inflation.

"The Fed continues to say that the outlook for employment and spending isn't as strong as the market perceives it," said Andrew Wilkinson, a senior market analyst for Interactive Brokers in Greenwich, Connecticut.

Analysts also noted the omission of any mention of a sharp spike in bond yields that threatens to thwart the Fed's campaign to lower borrowing costs. Yields on the benchmark 10-year Treasury are at highs not seen since May.

"Playing ostrich?" wondered UBS economist Maury Harris.

The Fed launched its program to buy longer-term Treasury securities early last month to support a weak economic recovery that was failing to generate jobs.

The Fed had already bought $1.7 trillion in longer-term assets from late 2008 through the beginning of this year in a bid to boost the economy after it had cut short-term interest rates to near zero.

The most recent bond-buying plan was assailed by critics, including foreign governments, concerned it could trigger inflation or set off a round of competitive currency devaluations by weakening the dollar.

Kansas City Federal Reserve Bank President Thomas Hoenig again expressed concerns that the program could destabilize the economy, the Fed's statement showed. He has dissented at every Fed policy meeting this year.

Consumer and business demand appears to be picking up, with a report on Tuesday showing a solid gain in retail sales in November. But the U.S. jobless rate jumped to 9.8 percent last month from 9.6 percent in October and core inflation is at record lows.

The economy looks set to get an additional boost from a deal between the White House and congressional Republicans to extend Bush-era income tax cuts that included a surprise reduction in payroll taxes. Some forecasters said the plan could lift growth next year by up to a full percentage point.

(Reporting by Mark Felsenthal and Pedro da Costa, editing by Chizu Nomiyama, Gary Crosse))