June 24 (Bloomberg) -- The Federal Reserve left its $1.75 trillion bond-purchase program unchanged and said inflation will remain “subdued for some time.”

“Substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time,” the Federal Open Market Committee said in a statement after a two-day meeting in Washington where it also kept the benchmark interest rate between zero and 0.25 percent. The rate will stay at “exceptionally low levels” for an “extended period.”

Chairman Ben S. Bernanke is watching to see how quickly the economy can recover from the deepest recession in five decades: Orders for durable goods unexpectedly rose in May, a government report showed today, while unemployment continues to climb. The Fed also wants to quell concerns that the $1 trillion expansion in its balance sheet will fuel inflation, pushing bond yields higher and crippling any rebound in the economy.

The central bank added that it “is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.”

The Fed also said “the pace of economic contraction is slowing” and noted “conditions in financial markets have generally improved.” Still, President Barack Obama said in an interview with Bloomberg News last week that the jobless rate will exceed 10 percent this year, a level not seen since 1983.

Today’s decision was unanimous. The Fed’s $300 billion Treasuries-purchase plan is scheduled to end in mid-September, according to the FOMC statement at the conclusion of the March 17-18 meeting, when it was announced. The Fed also committed to buy up to $1.45 trillion of housing debt this year. At its current rate, the Fed will reach the $300 billion of Treasuries by late August.

Expanding Balance Sheet

Total assets on the central bank’s balance sheet grew $1.17 trillion over the past year to $2.07 trillion as the Fed loaned to banks, commercial paper issuers, and purchased bonds outright to support the flow of credit to consumers and businesses.

“This is a very difficult period,” said Marvin Goodfriend, a former senior adviser at the Richmond Fed who is now an economist at Carnegie Mellon’s Tepper School of Business in Pittsburgh. “The Fed is exposed to a concern about inflation because it hasn’t committed itself to a low-inflation objective, yet the Fed may need the flexibility to expand its balance sheet further if the economy underperforms.”

Yields on U.S. 10-year Treasury notes are more than 1 percentage point higher than when the Fed announced the purchase program March 18, climbing to 3.67 percent at 8:37 a.m. in New York, from 2.53 percent. While central bankers have indicated they accept the increase as long as it reflects expectations for an economic recovery, a further increase may put such an outcome in jeopardy.

Mortgage rates have risen in tandem with yields, potentially delaying a rebound in the housing market. The average 30-year mortgage rate increased to 5.59 percent earlier this month, the highest since November, before slipping to 5.38 percent in the week ended June 18, according to Freddie Mac, the McLean, Virginia-based mortgage-finance company.

‘Too Low’

“Looking back, we are all cognizant of what transpired in 2003 and 2004 when the Greenspan Fed just left the federal funds rate too low for too long,” said Richard Schlanger, a vice president at Pioneer Investment Management in Boston who helps oversee about $13.5 billion in bonds. Bernanke succeeded Alan Greenspan at the Fed’s helm in February 2006.

Bernanke told Congress during testimony on June 3 that the Fed “will not monetize” U.S. debt, addressing concern that the central bank’s purchases of government debt might be used to finance deficit spending. Measures of overall inflation retreated in April while so-called core prices rose.

The personal consumption expenditures price index rose 0.4 percent for the year ending April. Oil prices tumbled from an average price of $112 a barrel in April last year to an average of around $50 a barrel the same month this year. Prices minus food and energy rose 1.9 percent for the year ending April.

“The challenge for us on the Federal Open Market Committee will be to shrink our balance sheet and tighten policy soon enough when the recovery emerges to prevent rising inflation,” Richmond Fed President Jeffrey Lacker said in speech in Raleigh, North Carolina, on June 10.

Inflation expectations have also increased. One such measure, the difference between yields on 10-year Treasuries and 10-year inflation-linked U.S. notes, rose to 1.84 percent yesterday from 1.41 percentage point at the start of last month.

Fed officials revised their estimates for growth, unemployment and inflation at today’s meeting. Their new forecasts will be available when the Fed publishes meeting minutes next month.

Private forecasters expect the economy to grow 1.9 percent next year, with inflation at 1.8 percent, according to the median estimates in a Bloomberg News survey. The unemployment rate will rise further, averaging 9.7 percent for 2010, according to economists in the survey. The jobless rate stood at 9.4 percent in May, the highest since 1983.

Job losses and record wealth destruction suggest consumer spending may not sustain the gains reported in the first quarter. Department stores Macy’s Inc. and Dillard’s Inc. and luxury chain Saks Inc. reported on June 4 that sales declined more than forecast in May. FedEx Corp. said last week that profits will trail analysts’ estimates because of an “extremely difficult” economy.

“A slow economic recovery is still a recovery, and sooner or later the Fed will take back their emergency rate cuts,” said Christopher Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd in New York. “As long as the low rates Fed pledge is conditional on the economic outlook, those green shoots are going to drive investors out of bonds.”

Money-market futures contracts show traders see a higher probability of a Fed rate increase in early 2010 than they did a month ago. Still, current data contain few signs that the economy will rapidly turn from recession to growth and accelerating consumer prices.

Industrial capacity use rates fell to a record low in May. Consumers pulled back on spending in both April and March as falling home prices, tighter credit, and high unemployment reduced confidence.

“The market sometimes gets ahead of itself, and this is one of those times,” Mark Zandi, chief economist at Moody’s Economy.com in West Chester, Pennsylvania, said before the announcement. “We will see core inflation continue to moderate given high and rising unemployment and excess capacity in almost every corner of the economy.”

To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net;

Last Updated: June 24, 2009 14:18 EDT