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The dollar edged higher against the euro and the yen after the Fed modestly upgraded its evaluation of the U.S. economic recovery and reaffirmed its commitment to purchase $600 billion in government bonds to boost the economy.

"The economic recovery is continuing, though at a rate that has been insufficient to bring down unemployment," the Fed said in a statement at the conclusion of a one-day meeting.

The Dow Jones industrial average touched a more than two-year high, and world stocks inched closer to overall two-year highs. Benchmark U.S. Treasury 10-year yields hit their highest levels in since May on signs of accelerating economic growth.

The government on Tuesday reported that U.S. retail sales rose for a fifth straight month, and the producer price index, a measure of business costs, increased more than expected, seen as a positive sign of demand.

"I'm slightly disappointed that the (Fed) doesn't see the world in the same light that investors do," said Andrew Wilkinson, senior market analyst at Interactive Brokers in Greenwich, Connecticut.

"The Fed continues to say that the outlook for employment and spending isn't as strong as the market perceives it."

Investors also kept their sights on a deal worked out between U.S. President Barack Obama and Republican lawmakers to extend tax cuts, jobless benefits and a payroll tax credit, which is expected to also boost the economy.

Wall Street did temporarily turn negative, weighed by declining bank shares after the Fed statement as hurt by a plunge in the stock of Best Buy Inc (BBY.N), the top U.S. electronics retailer that is seen a bellwether in consumer electronics. Best Buy shares fell 15 percent after it reported a drop in quarterly profit and sales and cut its full-year outlook, citing weak demand in its key U.S. market.

The Dow Jones industrial average .DJI was up 47.98 points, or 0.42 percent, at 11,476.54. The Standard & Poor's 500 Index .SPX was up 1.13 points, or 0.09 percent, at 1,241.59. The Nasdaq Composite Index .IXIC was up 2.81 points, or 0.11 percent, at 2,627.72.

The S&P 500 index is up 6 percent since November 29.

U.S. Treasuries extended losses after the Fed statement, adding to a sharp sell-off as the tax deal sparked concern over faster growth and a widening federal budget gap. U.S. Treasury 10-year yields, which influence consumer and corporate borrowing costs, rose to 3.44 percent from 3.28 percent late Monday.

GLOBAL OPTIMISM

European shares closed higher for a seventh straight session, reversing early losses after the U.S. retail sales data reinforced optimism about the pace of economic recovery. The FTSEurofirst 300 Index .FTEU3 finished up 0.3 percent in thin volume.

The MSCI world equity index .MIWD00000PUS edged up 0.24 percent, nudging closer to a two-year high set in November. The Thomson Reuters global stock index .TRXFLDGLPU rose 0.4 percent, and emerging stocks .MSCIEF added 0.6 percent.

In a statement that emphasized job market weakness and low inflation, the Fed characterized the U.S. expansion as "continuing," a modest upgrade from its November description of the recovery as "slow."

"The economic recovery is continuing, though at a rate that has been insufficient to bring down unemployment," the Fed said in a statement at the conclusion of a one-day meeting.

The sober assessment stood in contrast to increasingly optimistic forecasts on Wall Street, where analysts have been revising economic projections based on a slew of stronger-than-expected data and a new government tax cut plan.

As widely expected, the Fed offered no policy shift. It held overnight interest rates near zero, repeated a vow to keep rates exceptionally low for an extended period and renewed its pledge to buy about $75 billion worth of bonds a month to hold down long-term interest rates.

"What I think the Fed is trying to do is kick the can, so to speak, until their January 2011 meeting," said Joe Kinahan, chief derivatives strategist at TD Ameritrade in Chicago.

The dollar edged up against the euro and the yen as the Fed offered no sign of expanding its bond buying, but Treasury bonds extended losses on the central bank's dovish remarks.

On Wall Street, stocks were little changed after the statement and ended the day modestly higher.

GLOOMY OUTLOOK, DEFLATION CONCERNS

While offering a tempered acknowledgment of the apparent strengthening in the economy, the Fed maintained its focus on the two principle areas it is trying address: high unemployment and a slowing in already low inflation.

"The Fed continues to say that the outlook for employment and spending isn't as strong as the market perceives it," said Andrew Wilkinson, a senior market analyst for Interactive Brokers in Greenwich, Connecticut.

Analysts also noted the omission of any mention of a sharp spike in bond yields that threatens to thwart the Fed's campaign to lower borrowing costs. Yields on the benchmark 10-year Treasury are at highs not seen since May.

"Playing ostrich?" wondered UBS economist Maury Harris.

The Fed launched its program to buy longer-term Treasury securities early last month to support a weak economic recovery that was failing to generate jobs.

The Fed had already bought $1.7 trillion in longer-term assets from late 2008 through the beginning of this year in a bid to boost the economy after it had cut short-term interest rates to near zero.

The decline in business confidence was less than expected. But big manufacturers also expect conditions to deteriorate over the next three months, the closely watched tankan survey showed on Wednesday, boding ill for the fragile economy and keeping up pressure on the BOJ to maintain interest rates near zero.

BOJ policymakers are expected to scrutinize the survey at their rate review next week, although the central bank is seen holding off on easing monetary policy further after having taken action in October.

"The outlook for big firms and manufacturers felt a little weak," said Yoshiki Shinke, senior economist, Dai-Ichi Life Research Institute.

"The BOJ is likely to stick with its current status for a while ... Rather than economic indexes, the trigger (for further easing) is likely to come from the market, such as stocks falling greatly or the yen strengthening even more due to overseas events."

MURKY OUTLOOK

The headline index measuring big manufacturers' sentiment fell to plus 5 from plus 8 in September, marking the first decline in seven quarters. But it was higher than a median market forecast of plus 3.

The index for March next year was seen at minus 2, showing that the murky economic outlook was making companies even more cautious about business conditions in the coming three months.

That may hurt corporate capital spending, which is holding up relatively well for now.

Big firms plan to increase capital spending by 2.9 percent in the year to March 2011, slightly more than a median forecast for a 2.7 percent rise and recovering from a 15.5 percent decline in the year ended in March.

Japan's economy is expected to have contracted slightly in the final quarter of this year on slowing overseas growth and slumping factory output after the September expiry of government incentives for purchases of low-emission cars dented demand.

Analysts expect the country's economic growth to pick up early next year with support from exports to fast-growing Asia, but only modestly.

The BOJ has pledged to keep interest rates effectively at zero until the end of deflation is in sight and rolled out a 5 trillion yen ($60 billion) pool of funds to buy assets ranging from government bonds to corporate debt.

The central bank has said topping up the fund is a strong option if the economy worsens more than expected but it does not want to do so too soon.

The tankan's sentiment indexes are derived by subtracting the percentage of respondents who say conditions are poor from those who say they are good. Positive readings mean optimists outnumber pessimists.

(Editing by Edmund Klamann)

The vote signaled the latest win and a potentially fatal blow against Icahn in Lions Gate's long and costly war with the billionaire shareholder, who launched a hostile $7.50-a-share bid and for years has criticized the management of the studio that makes "Mad Men."

Lions Gate shares closed down 6.3 percent at $6.64 a share on the New York Stock Exchange.

Analysts said the stock fell on selling by investors who had bet on Icahn succeeding. "The merger arbs (arbitrage investors) are probably unwinding on what looks like the end of the Icahn saga," said David Bank, analyst with RBC Capital.

But Icahn is not going away altogether, even though he has abandoned his tender offer. As long as he retains his 33 percent stake, Lions Gate's largest and most vocal shareholder is likely to keep pressuring the studio to cut costs and raise its stock price, pursue litigation against it and advocate for a merger between Lions Gate and storied studio Metro-Goldwyn-Mayer, the focus of more legal wrangling between Lions Gate and Icahn.

"We are disappointed that shareholder democracy has failed -- or rather was subverted -- in the case of Lions Gate's annual meeting," said Icahn in a statement referring to a controversial debt-for-equity swap in July that effectively diluted his stake to 33 percent from 38 percent, hurting his chances in the proxy contest.

Icahn is seeking to unwind the swap; but Lions Gate last week gained an advantage when a New York judge denied Icahn's motion for an injunction to block Mark Rachesky, the company's second-largest shareholder, from voting shares he received in the transaction.

Icahn admitted on Monday it would be "virtually impossible" to win board seats after the court ruling but reiterated on Tuesday he was pleased there will be a full trial on the issue in the next few months, requiring Lions Gate to hold another shareholder meeting in September.

One of Icahn's nominees, Daniel Ninivaggi, was at Lions Gate's annual meeting and vowed to keep up the fight.

"We believe the vote is the direct result of bad corporate governance," Ninivaggi told Reuters.

Icahn announced he would not buy any shares tendered in his offer, which expired on Monday, because the bid had been conditioned upon receipt of the injunction.

Icahn is also expected to keep pushing for a merger with MGM, but Lions Gate said that for now it was not interested.

"We have said publicly that we were interested (in MGM) at one time, but for the moment that ship has sailed," said Michael Burns, vice chairman of Lions Gate, when asked whether the company would like to pursue a merger with MGM, which is expected to emerge from bankruptcy shortly.

In October, Lions Gate accused Icahn of secretly plotting to merge the two studios, but only after he acquired large stakes in both companies at depressed prices to ensure he maximized his own profits.

Earlier this month, MGM's reorganization plan won court approval, clearing the way for the studio to emerge from bankruptcy, and sources have said they expect the two studios to explore a merger.

(Editing by Gerald E. McCormick and Matthew Lewis)