In light of the weakening U.S. recovery, the Federal Reserve Board tacked from likely shrinking its balance sheet to keeping it inflated, but Bay Srteet economists note that the Fed isn’t ready to expand its stimulative efforts just yet.

As expected, the Fed left its target rate for the fed funds rate unchanged Tuesday at between 0 to 0.25% and reiterated that the rate will likely stay exceptionally low for an extended period.

“However the Fed went one step further in its attempt to consolidate the recovery by announcing it will keep the size of its portfolio at the current level,” notes Natonal Bank Financial, by announcing that it will reinvest principal payments from agency debt and mortgage-backed securities into longer-term Treasury securities. “Stopping the Fed’s portfolio from shrinking will prevent monetary policy from slowly tightening,” NBF says.

TD Economics says that with recent economic data, including the latest jobs report, showing a slowing in the recovery, “the Fed has moved its near-term stance away from potential withdrawal of monetary stimulus, towards the possibility of easing further.”

“The decision to reinvest the proceeds of previous purchases of mortgage backed securities in longer-term treasury securities is an important signal of this change in stance. From a policy of passive balance sheet contraction, the Fed has opened the door to further monetary stimulus. Moreover, by purchasing treasuries as opposed to agency debt, the Fed has made evident its preferred path should future easing become necessary,” it adds.

“The Fed’s actions today highlight its intention to do whatever is necessary to ensure that the recovery stays on course providing support via extremely low interest rates throughout the maturity spectrum. To be sure, the weaker round of economic data justifies the stance,” says RBC Economics. Still, it expects that the U.S. economy “will continue to grow at a moderate pace and that labour market conditions will slowly improve sets up for the Fed to maintain its policy stance until the second quarter of 2011.”

TD also notes that more policy easing is not assured, despite Tuesday’s statement. “This statement was cautious enough to note that at the current juncture the economy continues to improve, even if at a relatively slow pace. Moreover, given the uncertainty about the relative effectiveness of more quantitative easing and concern about its potential downsides, this statement reflects our belief that in absence of another shock to demand, a very gradual removal of monetary stimulus remains the most likely scenario to play out over the next year and a half,” it says.

NBF says that the performance of the labour market in coming months will be a key factor in whether the Fed decides further easing is needed. “If private jobs creation does not accelerate enough to bring the unemployment rate down, the Fed will have little choice but to dig further in its tool box in order to support the economy,” it says, adding, “At this stage, the Fed needs more convincing signs that the economy is on a slippery road in order to convince itself that a more aggressive stance is needed.”

IE