The Fed said it was unsatisfied with the pace of economic growth and felt the timing was not right to make a change in quantitative easing .

Stocks on the Dow industrials and S&P 500 averages surged to record highs on the news and bond yields moved sharply lower, with the benchmark 10-year note most recently at 2.76 percent.

An economy still stumbling toward recovery was not enough to sway the Federal Reserve, which defied market expectations Wednesday and said it will not begin pulling back on its monthly asset-purchasing program.

Fed Chairman Ben Bernanke said that while the economy is growing, fiscal tightening in Washington in the form of sequestration spending cuts remains a significant obstacle.

"The downside risks to growth have diminished over the past year," Bernanke said at a news conference. "However the tightening of financial conditions in recent months, if sustained, could slow the pace of improvement in the economy and labor market."

He stressed that any Fed moves toward the tapering will be dependent on economic data improvements.

After riling markets earlier in the summer with talk about reducing asset prices, Bernanke was less certain when talking to reporters.

He said the Fed would taper "at some point, possibly later this year," a contrast to his statement in June that a reduction would almost certainly happen later this year, with a wrap-up by mid-2014.

Traders cheered the developments, despite their somewhat dour implications for the state of the economy, with the belief that more QE would keep fueling the stock rally.

"The idea that the economy is still too weak to taper and market goes up has its limits," Leon Cooperman, manager of the Omega Advisors hedge fund, told CNBC. "If we keep going we are taking away from future returns."



Bernanke further insisted that market demands would not dictate Fed action.



Responding to a question of whether the Fed was confusing the markets, he defended his decision to raise the tapering issue.

"Failing to communicate that information would have risked creating a large divergence between market expectations, public expectations and what the committee intentions were, and that could have led to much more serious problems down the road," he said.



The Fed is buying $85 billion a month in Treasurys and mortgage-backed securities, with the greater weighting of $45 billion toward the former.



"Taking into account the extent of federal fiscal retrenchment, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy," the statement said.

"However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases."



(Read more: Taper: What Wall Street's favorite buzzword means)

The statement served both as a notice that the Fed remains in the easing game, and that it is unmoved by a recovery that has seen auto and home sales surge and employment show slow but steady growth.

Only Kansas City Fed President Esther George dissented from the vote.

"Clearly, the doves—focused predominantly on labor market slack and a fragile housing recovery—prevailed at today's meeting," Joe LaVorgna, chief U.S. economist at Deutsche Bank, said in a note to clients.

