Countering fears that it will be forced to take action to counter the threat of inflation, the Federal Reserve said Wednesday it expects to keep short-term interest rates "exceptionally low" for an extended period.

With the target rate for the federal funds overnight rate at zero to 0.25 percent, the Fed has run out of room for further reductions in short-term rates. But it reiterated a commitment to make $1.25 trillion in total purchases of mortgage-backed securities by the end of the year, continuing a program that many observers credit with keeping mortgage rates low.

The Fed did not raise a cap of $300 billion in purchases of Treasury securities, however, a policy that could eventually lead to higher interest rates on those investments if demand for them wanes.

Bond prices and yields move in opposite directions. Mortgage rates, although not tied directly to Treasurys, have risen in concert with Treasury yields in recent weeks as demand for mortgage-backed securities and Treasurys has slackened -- a reflection of fears that inflation is looming, some observers say.

The Mortgage Bankers Association this week reduced its forecast for total 2009 mortgage originations by more than $700 billion, or 27 percent, in part because of rising interest rates (see story).

The MBA said the Fed purchased about 85 percent of all mortgage-backed securities issued in March, April and May by Fannie Mae, Freddie Mac and Ginnie Mae.

The Fed was also behind about 50 percent of long-term Treasury purchases, but is approaching a self-imposed $300 billion ceiling, which it may be reluctant to increase. Worries that the Fed will eventually have to withdraw some of the liquidity it has injected into financial markets to nip inflation in the bud has also put pressure on Treasury yields, the MBA said.

The Fed's Open Market Committee issued a statement today at the conclusion of a two-day meeting, saying it continues "to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets."

Although energy and other commodity prices are on the rise, substantial "resource slack" is likely to keep a lid on prices, the statement said, and the committee expects that inflation "will remain subdued for some time."

The pace of economic contraction seems to be slowing, the committee said, and conditions in financial markets have generally improved in recent months.