The Fed had implemented 17 quarter-percentage point rate hikes since June 2004, raising the nation's benchmark rate from 1 percent to 5.25 percent, where it stood after today's meeting.

The Fed said economic growth was slowing, but that some inflation risks remain — meaning Fed officials could resume raising rates at subsequent meetings, the next one coming in September. However, with many on Wall Street concerned that the Fed could raise rates too far, possibly pushing the economy into a recession, the pause was welcomed even as uncertainty about future rate hikes weighed on stocks.

"We had been anticipating this pause for weeks now, and the accepted wisdom was that whatever they did was going to be anticlimactic for the market," said John Wilson, managing director of equity capital markets at Morgan Keegan. "This may be a little bit of selling on the news, sure, but I couldn't have asked for a better outcome from the Fed.

The Dow Jones industrial average fell 45.79, or 0.41 percent, to 11,173.59 after fluctuating shortly after the Fed's announcement.

Broader stock indicators also fell. The Standard & Poor's 500 index lost 4.29, or 0.34 percent, to 1,271.48, and the Nasdaq composite index dropped 11.65, or 0.56 percent, to 2,060.85.

Bonds were little changed after the Fed decision, with the yield on the 10-year Treasury steady at 4.92 percent from late yesterday. The dollar was lower against other major currencies, and gold prices also fell.

Oil prices traded lower as Energy Secretary Samuel Bodman sought to assure the market that Sunday's shutdown of the Prudhoe Bay oilfield in Alaska would not cause undue shortages. A barrel of light crude settled at $76.31, down 67 cents, on the New York Mercantile Exchange.

Energy costs are one of the lingering inflation pressures in the market that worry the Fed, and investors saw another warning sign early today after the Labor Department said worker productivity increased by just 1.1 percent in the second quarter, down from 4.3 percent in the first three months of the year. In addition, unit labor costs jumped 4.2 percent, the biggest increase since 2004. Economists believe slower productivity and higher costs could lead businesses to pass costs on to the consumer as higher prices, thus triggering inflation.

In its policy statement, the Fed left open the possibility of more rate hikes, depending on whether future economic data shows more signs of increasing inflation risk. Most analysts, however, took the statement as a sign that the Fed would continue holding steady.

"This wasn't necessarily a 'beer memo,' where you go off and have a beer after a job well done. The Fed is still a little cautious on inflation," said Jonathan Golub, managing director of the U.S. equity group at JP Morgan Asset Management. "Had they added a little more zing to it, you might have seen the market really take off. But I think we'll move higher in a few days after we've digested everything."

With the Fed decision weighing on the markets, investors largely overlooked a spate of takeovers and earnings reports. Food service company Aramark Inc. agreed to be taken private by a group of investors led by its chairman in a deal worth $6.3 billion, plus the assumption of $2 billion in debt. News of the deal, which values each share of Aramark at $33.80 per share, sent its stock 47 cents lower to $32.58.

Metal products maker Aleris International Inc. surged $11.52, or 28 percent, to $52.91 after it agreed to a $1.7 billion takeover offer from private equity firm Texas Pacific Group.

Caremark Rx Inc. led off another flurry of earnings reports with a 20 percent jump in second quarter profits. The pharmaceutical service provider also increased its full-year forecasts. Caremark added $1.05 to $55.69.

Packaged food producer Sara Lee Corp. fell 39 cents to $16.61 as it posted a fiscal fourth-quarter profit after a year-ago loss. The company beat Wall Street estimates after accounting for one-time charges, but full-year profits and revenues were lower than expected.

Contact lens maker Bausch & Lomb Inc. said it will delay filing its second-quarter earnings report and warned that its full-year profits could fall well below estimates due to the recall of its ReNu with MoistureLoc lens solution in May. Bausch & Lomb lost 27 cents to $46.07.

Declining issues outnumbered advancers by about 3 to 2 on the New York Stock Exchange, where preliminary consolidated volume came to 2.48 billion shares, compared with 2.11 billion traded yesterday.

The Russell 2000 index of smaller companies was down 8.58, or 1.23 percent, at 687.47.

Overseas, Japan's Nikkei stock average surged 2.05 percent. In Europe, Britain's FTSE 100 closed down 0.18 percent, France's CAC-40 gained 0.23 percent for the session and Germany's DAX index rose 0.45 percent.