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UPDATE 2-Fed to buy Treasuries; pump $1 trln into US economy

* Fed to buy $300 bln longer-term Treasuries

* Fed to expand mortgage agency debt buying to $1.45 trln

* Stocks, bonds surge, mortgage rates, dollar tumble (Recasts; adds details)

WASHINGTON, March 18 (Reuters) - The Federal Reserve on Wednesday said it would pump an additional $1 trillion into the U.S. economy to try to pull it out of a deep recession, partly by buying longer-term government debt for the first time in more than 40 years.

In a statement at the end of a regular two-day policy meeting, the central bank’s panel said it would buy up to $300 billion in longer-term Treasuries.

The decision caught many off guard. While the Fed has said it was considering such a move, it had seemed to be backing away from it recent weeks. As recently as March 6, New York Fed President William Dudley had said such a move would not be the most efficient way to ease market conditions.

The surprise announcement jolted markets. U.S. stocks shot higher and yields on U.S. government bonds took their biggest one-day tumbled since 1987, while the dollar plunged to a two-month low against the euro.

“When the Fed said it would ‘employ all available means’ to jump-start the recovery and prevent deflation it wasn’t kidding,” said Sal Guatieri of BMO Capital Markets in Toronto.

In addition to purchasing Treasury debt, the Fed said it would expand by $850 billion to $1.45 trillion an existing program to buy debt and securities issued by mortgage finance agencies.

The expansion of the program, which already had lowered mortgage rates, immediately pushed borrowing costs down further. Quicken Loans said rates on 30-year mortgages fell as much as 0.375 percentage point to 5 percent.

RATES NEAR ZERO

The Bank of England’s recent success in driving interest rates down by buying government debt may have been a factor in the U.S. central bank’s decision to buy longer-term Treasuries -- a strategy it last deployed in the 1960s.

By driving down yields on benchmark government debt, the Fed hopes to lower a wide array of borrowing costs for consumers and businesses.

“This is a pretty dramatic move ... They are trying to bring down all consumer rates,” said James Caron, head of global rates research at Morgan Stanley in New York.

In addition to ramping up its efforts to pump money into the recession-struck economy, the Fed unanimously decided to hold its target for overnight interest rates in a zero to 0.25 percent range -- the level reached in December. One Fed official, Richmond Federal Reserve Bank President Jeffrey Lacker, returned to the fold after dissenting in January.

The Fed said rates would stay low for “an extended period,” a more explicit vow to stay on hold with rates for a prolonged time than it had offered in recent months.

CREDIT EASING II

With benchmark interest rates virtually at zero for months, the Fed has turned its focus to flooding stressed credit markets with cash in the hope of restarting lending and restoring growth -- a policy Fed chief Ben Bernanke has dubbed “credit easing.”

“Bottom line is the Fed is adding a trillion dollars to their balance sheet and that’s a lot of taxpayer money,” said Greg Salvaggio, vice president for trading at Tempus Consulting in Washington.

Bernanke on Sunday said repairing the tattered financial system was necessary to secure a recovery for the U.S. economy, which has been stuck in recession for more than a year.

The Fed this week began taking bids for a program designed to spur student, auto, credit card and small business lending, and it said on Wednesday it would consider expanding that program to cover a wider array of assets.

The consumer and small business credit program will initially aim to inject $200 billion into the market for securities backed by these loans, but the Fed has already said that program could be ramped up to $1 trillion.

While the Fed has gone to extraordinary lengths to try to get credit flowing, the economy is still in a nose dive.

U.S. gross domestic product shrank at a 6.2 percent annual rate in the fourth quarter, the deepest contraction since early 1982, and economists expect a decline of 5 percent or more in teh first quarter. The unemployment rate, which has already hit a 25-year high of 8.1 percent, is expected to climb through the year. (Additional reporting by Glen Somerville; editing by Tim Ahmann and Chizu Nomiyama)

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