The new deal will keep the England midfielder at the club until 2013.
Liverpool boss Rafael Benitez told Liverpoolfc.tv: “This is fantastic news for the club.
“Steven has once again shown his commitment and it was an easy deal to agree. As soon as we offered him the option he said yes. There were no problems at all. He wants to stay for life.
“This deal sends out another clear message that we are moving forward as a club. To know we have a player of Steven’s quality with us for many more years is a great boost for the club and the fans.
“He is clearly a player who inspires those around him and even though he is playing very well at the moment, I still think his best years are ahead of him.”