By Pedro da Costa and Mark Felsenthal
WASHINGTON (Reuters) - The Federal Reserve maintained its ultra-loose monetary policy on Tuesday, saying the economy was gaining traction while flagging potential inflation risks from costlier energy and food.
The widely expected decision comes on a day of steep selling on stock markets around the world as investors assessed the devastating toll of Japan's earthquake and tsunami, and fretted over the possibility of a broader nuclear crisis.
The heightened uncertainty reinforced the case for a steady-as-she-goes policy decision from the Fed, which markedly upgraded its view of the U.S. recovery and labor market.
In a unanimous decision, the Fed vowed to continue its $600 billion government bond-buying program as scheduled, and reiterated a pledge to keep interest rates at very low levels for an extended period.
"The economic recovery is on a firmer footing, and overall conditions in the labor market appear to be improving gradually," the central bank said in a statement.
That was a much rosier assessment than it gave at the conclusion of its last meeting, in January, when it said that the recovery was still too weak to significantly bring down unemployment.
The Fed dedicated an unusually large portion of its statement to inflation concerns surrounding a recent spike in energy and food prices, which it said would most likely prove transitory.
"Long-term inflation expectations have remained stable, and measures of underlying inflation have been subdued," the Fed said, suggesting that it was in no rush to raise interest rates.
The statement made no direct mention of Japan.
The worst earthquake on record for the world's third- largest economy could have substantial ripple effects on the global recovery -- as evidenced by a sharp pullback in global equity prices, with Japanese stocks down over 10 percent on Tuesday alone.
Even before the tragedy, U.S. central bankers faced confusing signals. Despite high unemployment, rising energy costs appear to be nudging up the price expectations of U.S. consumers, the first inklings of an inflationary psychology the Fed would like avoid.
Fed officials managed that tension by beefing up their assessment of economic conditions while emphasizing just how far the central bank remains from its targets for both inflation and employment.
PROMISE AND PAIN
Since the Fed's last meeting in January, the U.S. economy has continued to show signs of promise. The U.S. unemployment rate has fallen rapidly, down to 8.9 percent in February from 9.8 percent in November.
Still, the pace of hiring suggests further progress will be painfully slow for the 8-million-plus Americans who lost their jobs during the economic slump of 2007-2009.
At the same time, higher gasoline costs have created fresh concerns for consumers, with a big hit to confidence this month raising concerns about whether a recent spurt in consumer spending can be sustained.
The U.S. economy expanded at an annual rate of 2.8 percent in the fourth quarter, a respectable performance but a faster pace will likely be needed to make a further appreciable dent in unemployment.
Some economists thought growth could approach 4 percent this quarter, but have pared back projections, in part because of an unexpected widening in the U.S. trade deficit.
The Fed effectively chopped overnight interest rates down to zero in December 2008 and then turned to buying mortgage and Treasury debt to keep long-term borrowing costs low. In all, it has committed to buying $2.3 trillion in debt.
The asset purchases have proven controversial, with domestic critics arguing the Fed is courting future inflation while officials in emerging markets have accused the central bank of trying to boost U.S. exports by devaluing the dollar.
With the economy strengthening, officials are also likely to have had a vigorous debate on how best to eventually tighten policy, but analysts will have to wait until Fed speakers take to the podium again to get a fuller flavor of the discussions.