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U.S. stocks flat to lower in muted reaction to Fed

(Updates to late afternoon)

By Haitham Haddadin

NEW YORK, March 18 (Reuters) - Stocks were flat to lower late on Tuesday afternoon as investors gave a muted reaction to the Federal Reserve's decision to leave U.S. interest rates unchanged but hinted it may lower them if war with Iraq takes a toll on the world's largest economy.

The U.S. central bank held rates steady at 1961 lows, as expected, but signaled it was ready to cut them quickly if needed, saying it would practice "heightened surveillance."

"The Fed is basically saying what the market was worried about all along, the geopolitical uncertainties," said Peter Cardillo, chief strategist at Global Partners Securities Inc. "The fact that the Fed did not change the bias is somewhat positive. But I think the market is having a reality check."

The broad Standard and Poor's 500 index , eased 1.37 points, or 0.16 percent, to 861.42. The tech-laced Nasdaq Composite Index shed 2.13 points, or 0.15 percent, to 1,390. The blue-chip Dow Jones industrial average was up 13.38 points, or 0.16 percent, to 8,155.

"It's unusual language that we're seeing. It's not that they didn't change the bias. It's that they don't want to make a decision on the bias," said Elisabeth Stoegmueller, economist at Dresdner Kleinwort Wasserstein in New York.

"Right now, there are a lot of uncertainties in the economy ..I think the Fed wants to wait to see the underlying economic factors before making a decision, and is keeping its options open until that time."

Investors tip-toed, leaving the market flat for much of Tuesday's session after a big rally on Monday, waiting to see if a likely military strike on Iraq goes smoothly for the United States before pouring more money into the stock market. Iraqi President Saddam Hussein scorned an ultimatum by President George W. Bush giving the Iraqi leader 48 hours to flee or face war.

The Dow is up 8 percent since the close last Wednesday when the gauge came close to touching multiyear lows. Last week's rise in the markets pushed the Nasdaq into positive ground for the year.

Questions also arose about the health of the U.S. economy after a report showing a tumble in U.S. housing starts last month.

Tobacco stocks were slammed after a New York Times report that the U.S. Justice Department, alleging a half-century of "fraudulent" and dangerous market practices, is demanding that the biggest U.S. cigarette makers be ordered to forfeit $289 billion in profits.

Altria Group Inc., a Dow component, sank $2.16, or 6.2 percent, to $32.56. R.J. Reynolds Tobacco Holdings Inc. sank $2.91, or 8 percent, to $33.78. UST Inc. dropped 59 cents, or 2 percent, to $27.50.

The S&P homebuilding index fell 1.22 percent after the disappointing report on housing starts. It was reflecting losses by issues such as Centex Corp. , down 62 cents to $51.98.

Dow stock Procter & Gamble Co. rose 72 cents to $86.22. The consumer products giant raised its quarterly profit outlook. The company also said it would take control of German hair care firm Wella in a $5.7 billion deal, giving P&G a boost against French rival L'Oreal .

Gateway Inc. fell 6 cents, or 2.5 percent, to $2.34. The No. 3 U.S. personal computer maker has warned its first-quarter results would widely miss forecasts and said it would slash its work force by 17 percent in a bid to cut annual costs by over $400 million.