Fed sticks to stimulus, worried about growth soft spots

By Pedro da Costa and Alister Bull

WASHINGTON (Reuters) - The U.S. Federal Reserve said on Wednesday that it would continue buying bonds at an $85 billion monthly pace for now, surprising financial markets that were braced for a reduction in the central bank's economic stimulus.

Citing strains in the economy from tight fiscal policy and higher mortgage rates, the Fed decided against the tapering of asset purchases that investors had all but priced into stock and bond markets.

"The committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases," the U.S. central bank said in a statement announcing its decision. Esther George of the Kansas City Fed again dissented, saying she was worried about financial bubbles due to the Fed's low rate policy.

Fed Chairman Ben Bernanke will hold a news conference at 2:30 p.m. (1830 GMT) to elaborate on the central bank's thinking.

The move comes against the backdrop of a somewhat gloomier outlook for economic growth from U.S. Fed officials. In a new set of quarterly forecasts, the Fed now sees growth in a 2 percent to 2.3 percent range this year, down from 2.3 percent to 2.6 percent in its June estimates. The downgrade for next year was even sharper: 2.9-3.1 percent from 3.0-3.5 percent.

Most policymakers, 12 out of 17, also projected the first official interest rate hike will come in 2015. That's despite forecasts for unemployment to potentially reach 6.5 percent, the threshold at which rate hikes will begin to be considered, sometime next year.

To temper any market jitters from a slowing in its purchases, the Fed reiterated that it will not start to raise rates at least until unemployment falls to 6.5 percent, so long as inflation does not threaten to go above 2.5 percent. The U.S. jobless rate in August was 7.3 percent.

The reduction in bond buying marks a milestone in what is expected to be a slow road back toward normalizing policy after an unprecedented five year episode of monetary expansion that has been felt worldwide.

(Editing by Krista Hughes)