Fed chairman Alan Greenspan has signalled further rate cuts

But the bank surprised analysts by warning the US economy is in danger of further weakness in the months ahead.

Its statement was taken as a sign that further cuts in the cost of borrowing could be in the pipeline.

"If inflation comes down in the next month or two, they could easily cut rates again," said Dominic Konstam, head of interest rate strategy at Credit Suisse First Boston.

Deflation risk

The Fed had been expected to take a neutral view of economic prospects or not an issue an assessment at all, as it did in March.

This is, I think, a positive statement by the Fed for the market Peter Cardillo, Global Partners

Instead, the Federal Open Markets Committee (FOMC) separated the risks to the US economy into two parts.

It said the outlook for growth was balanced - but the risk of a slide toward deflation was greater than of a pickup in inflation.

The FOMC kept the headline federal funds rate for overnight loans between banks at 1.25%, where it has been since last November.

The markets initially shed some gains after the Fed's decision but soon returned to positive territory, at roughly the same level as before the announcement.

'Pleased'

Commenting on the Fed's decision, Linda Duessel. senior vice president an senior portfolio manager at Federated Investors, said: "We're not surprised by this at all.

"We're pleased that it sounds as if they are willing to ease if it were needed.

"There could be a little pullback in the stock market but that would be a positive after the terrific run that we've had."

Peter Cardillo, chief strategist at Global Partners securities, New York, said: "I think what the Fed is saying here is the risk of deflation vs. inflation is still there.

"But we do believe that the economy is going to pick up steam in the second half, so basically this is, I think, a positive statement by the Fed for the market."

Jobs market

Carl Tannenbaum, chief economist at Lasalle Bank, Chicago, said: "The reality is the Fed saw many of the same things the rest of us saw.

"Now that the sand has cleared, it is becoming more obvious that there is more that is troubling the economy than troubles in the Middle East."

He said the Fed had put the market's "on notice" of a further rate cut.

Policymakers would be watching whether the job market - which has performed poorly in recent months - shows signs of stabilizing, he added.

William Hummer, senior vice president, Wayne Hummer Investments, Chicago, said: "I think this will prove very reassuring and soothing to the market.

"If they had cut rates, the perception would be that the Fed saw trouble ahead in the economy."