By Alister Bull

The Fed, which will issue a policy statement around 2:15 p.m. EST on Wednesday at the end of a two-day meeting, is searching for ways to end a deepening year-long recession and restore confidence to businesses and consumers shocked by the financial havoc wrought by a housing market collapse.

A report on Friday is expected to show the U.S. economy suffered its deepest quarterly contraction since 1982 in the final three months of last year.

Economists said the U.S. central bank will leave the target range for the benchmark overnight federal funds rate unchanged at zero to 0.25 percent, and repeat an assurance that rates will remain exceptionally low for some time.

They also expect guidance on how aggressively the Fed will keep supporting credit markets by expanding its balance sheet, and possible hints on purchases of U.S. government bonds, but they said the Fed faces a tough task communicating its aims.

"The easy part is (leaving) the funds rate unchanged and the language about keeping exceptionally low rates ... that will stay," said Michael Feroli, an economist with JPMorgan in New York.

Obama's economic team is working to overhaul the U.S. response to a worsening home foreclosure and bank crisis. Timothy Geithner, the president's nominee for Treasury secretary, told Congress last week that Obama would lay out his strategy in the next few weeks.

WAITING ON OBAMA

With the administration's crisis-response plans not yet cemented, the Fed may be hindered in launching any more major initiatives, because taxpayer money might be needed for the central bank to widen its programs to cover riskier assets.

"I really don't think we're going to see anything major right away," former Fed Governor Lyle Gramley said.

After lowering interest rates from 5.25 percent in September 2007 to near zero last month, the Fed has pointedly switched to a policy aimed at easing credit market conditions.

It has flooded markets with dollars to keep them from freezing in panic over bank losses, in the process doubling the size of its balance sheet to more than $2 trillion. It is also mulling purchases of U.S. government bonds.

The Fed has also pledged to support auto, student, credit- card and small-business loans through a $200 billion program -- the Term Asset-Backed Securities Loan Facility, or TALF -- due to start next month.

Under TALF, the Treasury pitched in $20 billion to underwrite the Fed's investment. Officials have said the program could be expanded to cover securities tied to commercial mortgages and an array of home loans.

"We would expect some comments on the TALF, what will be included and will it be expanded, and we would also expect some comment on Treasury securities purchases," said Dean Maki, co-chief U.S. economist at Barclays Capital in New York.

TALKING TARGETS

Long-dated U.S. government bonds enjoyed a big rally last month after Fed Chairman Ben Bernanke said the central bank could step in as a buyer to lower borrowing costs. In a statement after their last meeting on December 15-16, officials said they were examining that option.

"If they take that statement (on Treasuries) out ... it is probably an indication that they don't plan to do it," Maki said, warning it could spur a big bond sell-off.

Policy-makers may also continue a discussion they had at their December meeting on whether an explicit inflation target could help keep a self-feeding deflationary psychology from taking hold. If a broad-based decline in prices set in, it could further undercut the already weak economy.

St. Louis Federal Reserve Bank President James Bullard and Richmond Fed chief Jeffrey Lacker, anti-inflation hawks who have voiced concern that the vast sums of cash the Fed has pumped into credit markets might eventually spark inflation, have both said a target could help anchor expectations and ensure price stability.

"They might throw a bone to them by adopting an explicit inflation target. My own feeling is that it is not going to do any good at this point," Gramley said.

(Editing by Maureen Bavdek)