The Federal Reserve on Tuesday said the US economic recovery is "more modest" than expected and it will buy Treasury debt, in a signal that it will take more extensive measures if necessary.

The Fed's decision to buy small amounts of government debt was seen by analysts as a confirmation that the central bank will not scale back the emergency support measures that it has put in place since 2007. While purchasing new Treasury securities at a rate of $10bn to  $20bn a month, compared with about a total of $700bn on the Fed’s balance sheet, is not significant, it leaves open the possibility of more aggressive moves, if the recovery was to continue to weaken.

In a downgrade of its assessment of the economy, the policy-making Federal Open Market Committee (FOMC) said the recovery "has slowed in recent months," and that the "pace of economic recovery is likely to be more modest in the near term than had been anticipated." The committee reaffirmed its commitment to keep its target for the benchmark federal funds rate, at which banks lend to each other overnight, at "exceptionally low levels" for an "extended period."

The US economy grew at a 2.4% annualised rate in the second quarter and the Bureau of Economic Analysis reported that the worst US recession since the 1930s was even worse than previously estimated, reflecting bigger dips s in consumer spending and housing, according to annual revisions released on July 30th. GDP grew at a rate of 3.7% in Q 1 2010 and 5.0% in Q4 2009.

The world’s largest economy shrank 4.1% from the fourth quarter of 2007 to the second quarter of 2009, compared with the 3.7% fall previously reported, the report showed. Household spending fell 1.2% in 2009, twice as much as previously projected and the biggest drop since 1942.

In its statement Tuesday, the Fed noted that high unemployment, modest income growth, lower housing wealth and tight credit were holding back household spending. Meanwhile, lending by banks "has continued to contract," it said, while construction remains weak and employers remain reluctant to increase payrolls.

The stock market responded to the FOMC statement with the Dow rising more than 100 points but it closed down 54.50 points, as investors reacted to the Fed's downbeat outlook for the economy.

Michael Gapen of Barclays Capital commented: "Changes to the FOMC statement indicate that the Fed has lost some confidence in the strength of the recovery… Our view is that simply reinvesting the proceeds from maturing agency securities will not provide much additional stimulus and, should the outlook continue to worsen, then the Fed will likely initiate a new round of asset purchases, most likely in Treasury securities."

Steven Ricchiuto, Mizuho Securities said: "The makers of domestic monetary policy took the middle road between doing nothing and expanding quantitative easing. Maintaining the extended period language and dampening their current assessment of the economy were non-events. The decision to re-invest maturing Agency and Agency MBS was maintaining the status quo. If the Fed had wanted to make a statement they would have added to the size of the quantitative easing."

The Fed decides to keep fund rates unchanged. Insight with CNBC's Eamon Javers & Steve Liesman; trillion and multi-billion fund managers William Gross, Pimco and Ken Volpert, Vanguard Funds:

The FOMC Statement:

Information received since the Federal Open Market Committee met in June indicates that the pace of recovery in output and employment has slowed in recent months. Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls. Housing starts remain at a depressed level. Bank lending has continued to contract. Nonetheless, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be more modest in the near term than had been anticipated.

Measures of underlying inflation have trended lower in recent quarters and, with substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve's holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities.The Committee will continue to roll over the Federal Reserve's holdings of Treasury securities as they mature.

The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh.

Voting against the policy was Thomas M. Hoenig, who judges that the economy is recovering modestly, as projected. Accordingly, he believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted and limits the Committee's ability to adjust policy when needed. In addition, given economic and financial conditions, Mr. Hoenig did not believe that keeping constant the size of the Federal Reserve's holdings of longer-term securities at their current level was required to support a return to the Committee's policy objectives.