Sept. 23 (Bloomberg) -- The Federal Reserve will slow its purchases of mortgage securities, seeking to avoid disrupting the housing market as an economic recovery takes hold.

“The Committee will gradually slow the pace of these purchases in order to promote a smooth transition in markets and anticipates that they will be executed by the end of the first quarter of 2010,” the Federal Open Market Committee said in a statement today after meeting in Washington. The $1.45 trillion program was scheduled to cease by the end of this year.

Chairman Ben S. Bernanke and his fellow policy makers indicated for the first time since August 2008 that the economy is accelerating, even as they recommitted to keep their benchmark interest-rate “exceptionally low” for an “extended period.” Today’s statement signals the Fed will maintain its stimulus measures to secure a recovery and reduce unemployment.

“The mortgage market has gotten a reprieve, and mortgage rates may stay low going into the spring of next year,” said Christopher Rupkey, chief financial economist at Bank of Tokyo- Mitsubishi UFJ Ltd. in New York. The FOMC indicated it will exit its emergency programs “only when the economy’s troubles have passed,” he said.

Bernanke is trying to revive lending and cut the 9.7 percent unemployment rate while preventing a surge in inflation from the $1 trillion expansion of the Fed’s balance sheet.

Stock Rally

The central bank’s purchases and the Obama administration’s homebuyers’ tax credit helped stabilize housing and push the Standard and Poor’s Supercomposite Homebuilding Index up more than 30 percent this year.

Fed officials signaled a stronger commitment to support housing markets, saying they would buy “a total of” $1.25 trillion in mortgage-backed securities. Last month, they said they could buy “up to” that total.

Stocks retreated after initially extending gains. The Standard & Poor’s 500 Index was down 1 percent to 1,060.87 at 4:30 p.m. in New York following an increase of as much as 0.8 percent. Treasury notes gained.

Officials left the target rate for overnight loans between banks at a record low of between zero and 0.25 percent. Today’s decision was unanimous.

“Economic activity has picked up following its severe downturn,” the committee said today. “Conditions in financial markets have improved further, and activity in the housing sector has increased,” the Fed said.

“Household spending seems to be stabilizing, but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit.”

Economic Slack

The FOMC said monetary and fiscal stimulus combined with stabilizing financial conditions “will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability.”

Policy makers gathered a week after Bernanke told a conference in Washington that the worst recession since the 1930s “is very likely over.” Forecasters anticipate the expansion will be “moderate” because of “ongoing headwinds,” including cuts in lending by banks, he said in response to questions at the Brookings Institution.

FedEx Corp., the second-largest U.S. package-shipping company, reported Sept. 17 the smallest drop in international shipments in a year. United Technologies Corp., the maker of Otis elevators and Carrier air conditioners, can return to profit growth next year as it benefits from cost cuts and a revival in some markets, Chief Financial Officer Greg Hayes told a JPMorgan Chase & Co. conference broadcast on the Internet.

‘Key Message’

“The key message here is we see tough markets; some signs of improvement on the short cycle; confident in 2009 and confident that we are going to resume earnings growth in 2010,” Hayes said. Hartford, Connecticut-based United Technologies, which also owns Pratt & Whitney jet engines, is eliminating at least 18,000 jobs to reduce costs and boost margins once the economy improves.

The Fed has bought about $862 billion of its $1.25 trillion agency mortgage-backed securities program, and $129.2 billion of a $200 billion program of U.S. agency bonds. Demand is returning to housing after the industry shaved an average of 1 percentage point from gross domestic product each quarter since the start of 2006.

Home prices rose 0.3 percent in July from the previous month, the third straight monthly gain, according to a Federal Housing Finance Agency index. Existing home sales rose 7.2 percent in July from the prior month to the highest level in almost two years, according to the National Association of Realtors.

‘Primary Goal’

The Fed’s “primary goal is to avoid a shock to the market by suddenly shutting the programs down all at once,” said Christopher Low, chief economist at FTN Financial in New York. As the Fed eases out of purchases, “they’re hoping other buyers will step in to avoid a sudden increase in mortgage rates,” he said.

Mortgage rates for 30-year fixed home loans averaged 5.04 percent in the week ended Sept. 17, down from 5.07 percent the previous week, according to McLean, Virginia-based Freddie Mac, a government-controlled mortgage-finance company.

A sudden end to the Fed’s purchases might push up mortgage rates by a half to one percentage point, according to Peter Hooper, chief economist at Deutsche Bank Securities Inc. in New York.

Slower Pace

Tapering off -- by reducing weekly purchases and stretching them beyond the end of the year -- would have a more muted effect, pushing rates up by at least a quarter of a percentage point, Hooper said before the decision. Officials in August slowed the pace of their Treasury note-buying and considered doing the same with their mortgage-backed security and agency bond purchases, according to the minutes of the meeting.

Some economists said it will be hard for the Fed to withdraw its stimulus. Keeping it in place for too long, meanwhile, could lead to faster inflation. The U.S. monetary base, the stock of money in the banking system, doubled to $1.70 trillion in August from $842 billion a year earlier.

The FOMC’s statement said “substantial resource slack” and stable long-term inflation expectations mean that “the Committee expects that inflation will remain subdued for some time.”

Fed officials forecast in June that the personal consumption expenditures price index will rise 1.2 to 1.8 percent next year, within their long-term preference range of 1.7 to 2 percent. Economists say the inflation concerns are more about the risks that the Fed doesn’t shrink the balance sheet in time, or can’t do so because of further job losses.

Inflation Outlook

“Inflation is going to stay low for a while; the real concern about inflation is a long-run issue” Mickey Levy, chief economist at Bank of America Corp. in New York, said before the announcement. “The issue is will the Fed be able to drain and offset the huge increase in the monetary base before it reignites excess demand or inflationary expectations.”

Economists project an annualized growth rate of 2.9 percent in the third quarter, followed by an expansion of 2.2 percent in the final three months of the year, according to the median estimate in a Bloomberg News survey.

Manufacturing is expanding, and rising stock prices and real-estate values boosted household wealth by $2 trillion in the second quarter, the Fed said last week. Gains in household wealth helped support a 2.7 increase in retail sales last month, the most in three years.

“It’s one thing to have a resumption of growth, but it’s another thing to get back all the lost opportunities and all the jobs that have been lost,” said Robert Eisenbeis, chief monetary economist at Cumberland Advisors Inc. in Vineland, New Jersey. “That’s going to take a long time.”

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

Last Updated: September 23, 2009 18:07 EDT