The Federal Reserve sees a moderate economic recovery continuing in 2010, but needs to keep interest rates exceptionally low for an extended period to foster job growth, a Fed policymaker said on Monday.

Fed Governor Elizabeth Duke told an economic forum that slack in the economy was likely to remain above historical norms for some time, helping to keep inflation subdued.

In the current environment, the FOMC continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period, Duke said, referring to the U.S. central bank's policy-setting Federal Open Market Committee.

Such policy accommodation is warranted to provide support for a return over time to more desirable levels of real activity and unemployment in the context of price stability.

The Fed cut interest rates to near zero in December 2008 and created a host of emergency lending facilities to fight the worst recession in more than 70 years. It has pledged low rates for an extended period.

Fed watchers have focused on any changes in that language for clues to the timing of a possible tightening of monetary policy as the economy recovers. The FOMC maintained the extended period stance in its last statement on December 15.

MODERATE, SLOW RECOVERY

In remarks to the Economic Forecast Forum in Raleigh, North Carolina, Duke said recent data on production and spending suggested that economic activity continued to increase at a solid rate during the final months of 2009 after real GDP turned positive in the third quarter. A copy of her remarks was made available in Washington.

I expect to see a continued moderate recovery in economic activity in 2010, supported by a further healing in financial markets and accommodative monetary policy, Duke said.

But echoing comments by Fed Vice Chairman Donald Kohn in Atlanta on Sunday, Duke said constraints on lending would slow recovery.

She noted that there were still strong headwinds in the housing market, which is being buffeted by high numbers of foreclosures, tight credit for home builders and reduced mortgage availability for some households. Commercial real estate also faces challenges from vacancies brought on by loss of jobs, and the sector will lag the improvement in the overall economy.

She said credit also remains tight for businesses, and her outlook for continued growth depends on further progress in repairing financial markets and restoring the flow of credit to households and businesses.

But should economic conditions and the outlook change significantly, she said the Fed would adjust its policy stance and had a wide range of tools for removing monetary policy accommodation when that becomes appropriate.

Furthermore, Duke said companies are reluctant to hire because pressure to control costs and hold efficiency gains will remain strong until recovery is more certain.

As a result, I expect that businesses will begin to add jobs this year, but I anticipate that they will do so cautiously in order to hang on to their cost savings and efficiency gains, she added. Even as the unemployment rate begins to decline later this year, it likely will remain high by historical standards.

(Reporting by David Lawder, Editing by Neil Stempleman)

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