By Mark Felsenthal and David Lawder

WASHINGTON (Reuters) - The U.S. Federal Reserve on Wednesday expressed growing confidence that an economic recovery was building, even though it stuck to its commitment to keep borrowing costs near zero for "an extended period."

In a unanimous vote, the Fed's policy-setting Federal Open Market Committee decided to keep its benchmark federal funds rate unchanged in a range of zero to 0.25 percent, as expected.

It said the economy had "continued to pick up" since its last meeting in September, but expressed concern that the economy's recovery was likely to be sluggish.

"Household spending appears to be expanding but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit," the U.S. central bank said in a statement outlining its decision.

The Fed also said it would buy about $175 billion of debt issued by government-backed mortgage finance agencies, less than the $200 billion maximum it had originally allotted, citing limited availability.

U.S. stocks briefly pared gains, while prices for U.S. government debt fell sharply on the announcement. The U.S. dollar extended losses against the euro.

"I would say there are no surprises at all. If there is any surprise, it sounds like there is not even any hint that they are going to raise rates soon," said Robert MacIntosh, chief economist at Eaton Vance Corp in Boston. "We've got a number of Fed meetings to go before we will get any kind of increase."

MORE UPBEAT, BUT STILL WORRIED

The Fed's closely watched policy statement was somewhat more upbeat than its statement in September, which had referred to spending as "stabilizing."

However, it was also more explicit about why it expects to be able to keep overnight rates, which it cut close to zero in December, exceptionally low for a long time, citing "low rates of resource utilization, subdued inflation trends, and stable inflation expectations."

The central bank, wary of undercutting the fragile recovery by withdrawing its support too soon, has also been on guard for any indication that its emergency lending efforts could fuel an unwelcome bout of inflation down the road.

But top Fed officials, including Chairman Ben Bernanke, have said the U.S. recession, the most painful since the 1930s, has left a legacy of high unemployment and idle factories that should keep price pressures in check.

A private report on Wednesday showing U.S. companies cut payrolls at the slowest pace in more than a year may add to a sense that the economic numbers are moving in the right direction.

However, while the government on Friday is expected to report that the drop in employment is abating, the jobless rate is forecast to rise to a fresh 26-year high of 9.9 percent.

The world's largest economy grew at a faster-than-expected 3.5 percent annual rate in the third quarter, which effectively signaled the end of the downturn.

Suggesting further momentum, data on Monday showed manufacturing activity hit its highest level in 3-1/2 years last month, though a report on Wednesday showed the nation's vast services sector was growing only modestly.

WRESTLING WITH AN EXIT

In an act demonstrating confidence in the economy's prospects, billionaire investor Warren Buffett on Tuesday said his company, Berkshire Hathaway Inc, agreed to purchase the nation's largest rail company, saying it is poised to benefit from the recovery.

While the outlook has improved, many economists still expect the recovery to be sluggish and in need of the Fed's easy-money policies for a while longer.

Unemployment is expected to climb into next year, damping consumer spending, which accounts for around 70 percent of U.S. output. The banking system is still under pressure from loan losses, and credit remains tight.

Most analysts at top U.S. banks have been expecting the Fed to keep interest rates on hold until mid-2010 or later.

Even before it raises rates, the central bank is expected to begin to withdraw some of the enormous amounts of cash it pumped into the economy after chopping rates to near zero. That withdrawal of liquidity from the financial system is seen as key to containing inflation risks.

Other central banks are also wrestling with how best to spur growth and when to withdraw extraordinary measures to support their economies.

The European Central Bank is expected to keep rates on hold at a record-low 1 percent on Thursday, while there is a good chance the Bank of England will expand its large asset purchase program at a meeting the same day.

(Additional reporting by Pedro Nicolaci da Costa, David Lawder and Emily Kaiser; writing by Mark Felsenthal and Emily Kaiser; editing by Tim Ahmann)