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U.S. stocks head lower after Fed decision

(Updates with reaction to Fed decision)

By Haitham Haddadin

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

The broad Standard and Poor's 500 , virtually flat ahead of the Fed decision, was last off 3.17 points, or 0.37 percent, to 859.62. The tech-laced Nasdaq Composite Index shed 4.30 points, or 0.31 percent, to 1,387.97. The blue-chip Dow Jones industrial average , up a little earlier, lost 2.24 points, or 0.03 percent, to 8,139.68 after the Fed decision.

The U.S. central bank held rates at 1961 lows, as expected, but signaled it was ready to cut them quickly if an Iraqi war takes an economic toll by 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."

"We have come up sharply on the pretense that we will have a short war but we are not engaged in war just yet. Once the bombs start to fall the progress of the war will be noted."

In the past, the Fed's inclusion of such language often has foreshadowed rate reductions between regular meetings of its policy-setting Federal Open Market Committee. The FOMC is currently scheduled to meet again on May 6.

Investors tip-toed today, leaving the market flat for much of Tuesday's session after a big rally on Monday, as they waited 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.