The report, gathered from respondents in the 12 Fed districts through January 5, portrayed a gloomy economic scene, and suggests the Fed may need to implement further measures to thaw frozen credit markets and restore lending.

"The economy is terrible and the financial market is still a mess," said David Wyss, chief economist for Standard & Poor's in New York.

The blue-chip Dow Jones industrial average pared losses after the report but was still down more than 200 points on the day.

Retail sales were generally weak during the holiday season, despite deep discounting in most areas, the Fed said.

The Fed said lending activity declined or stayed weak in many areas, and credit conditions were tight or getting tighter.

Commercial real estate markets deteriorated, and reports about commercial construction were downbeat, the report said.

Against that backdrop, various Fed districts reported more workers losing jobs, hiring freezes, and reduced hours for some employees. The New York district reported that "substantial" job reductions have yet to show up in payrolls data.

Fed Chairman Ben Bernanke on Tuesday said the central bank would be able to boost the economy even though official interest rates are near zero by continuing to deploy such unorthodox measures as direct lending to financial institutions, providing liquidity to certain markets, and buying longer-term securities.

(Reporting by Mark Felsenthal, Editing by Neil Stempleman)