Fed seen hewing to easy-money course

WASHINGTON (Reuters) - The U.S. Federal Reserve began a two-day meeting on Tuesday that is expected to end with a reaffirmation that policies to support the economy will stay in place for some time, even as signs of recovery mount.

In particular, the Fed is not expected to soften its commitment to hold benchmark interest rates exceptionally low for "an extended period."

While the U.S. economy appears to have broken free of its deepest recession since the 1930s, doubts remain about whether a recovery can be sustained without government backing.

"It doesn't seem that it would do the Fed much good at this point to alter that language," said Barclays Capital economist Michelle Meyer. "They're much more concerned about the sustainability of the recovery ... rather than inflation concerns."

The Fed will issue a statement around 2:15 p.m. (7:15 p.m. British time) on Wednesday. While it is expected to nod to modestly encouraging economic signs, analysts expect a cautious tone on policy.

The economy grew at a 3.5 percent annual pace in the third quarter, the government said last week. Reports on Monday showed manufacturing activity rallied in October and pending homes sales surged unexpectedly in September.

Fed officials have taken note of the widening signs of recovery, but with unemployment likely to move higher, they have said ensuring the upturn does not wither is a priority.

"We have to think about our exit policy and are looking at it very carefully, but at the moment, that's not our first order concern. At the moment, it's policy accommodation," Chicago Federal Reserve Bank President Charles Evans, a voter on the Fed's policy-setting panel, said on October 22.

LOOKING FOR THE EXIT

The Fed cut rates to near zero in December to support the economy through a debilitating credit freeze and the recession that came with it. Its purchases of $1.75 trillion in longer-term government securities and mortgage-related debt are due to be completely phased out by the end of March.

"I don't think the recovery is clearly self-sustaining at this point," said Maurice Obstfeld, an economics professor at the University of California at Berkeley. "I think the Fed will be extremely sensitive to being perceived as withdrawing stimulus prematurely."

Financial markets are on tenterhooks in anticipation of any sign the Fed may start to trim its extensive stimulus measures, which have pumped hundreds of billions of dollars into the financial system and more than doubled the central bank's balance sheet.

The New York Federal Reserve Bank has begun testing one such tool, reverse repurchase agreements in which the Fed would sell Treasury securities for short periods to banks to drain liquidity from the financial system.

However, the Fed stressed those tests were trial runs and should not be taken to mean it was about to use them. Other arrows in the Fed's quiver include raising the interest on the reserves banks hold at the Fed and offering to banks term deposits akin to the certificates of deposit bank customers can obtain.

Most analysts at top U.S. banks expect the Fed to keep interest rates on hold until mid-2010 or later, although interest rate futures markets are pricing in an increase earlier in 2010.

Fed officials must also weigh the impact of their decision on global market forces.

The U.S. central bank's easy money policies have weakened the dollar and, in the view of many analysts, driven up the price of oil and other commodities. A number of Asian economies have intervened to curb strength in their currencies to support exports.