"Financial markets don't require shock treatment anymore," said Meny Grauman, economist at CIBC World Markets, who said the Fed now has some breathing room.

Grauman said inflation levels are "definitely elevated" and "worrying," but the recent downward change in federal funds futures isn't caused by inflation expectations, which have been elevated for some time now, but by the relative stabilization in credit markets seen since the bail out of Bear Stearns.

In early April, Fed funds futures were looking for at least a 25 basis point cut with a 50% chance of a half-point reduction, but in the past two weeks, expectations have been downsized. As of late Tuesday, Fed funds futures were pricing in an 82% chance of a quarter-point reduction, and of the 80 economists surveyed by Bloomberg this week, only a handful were looking for a half-point cut.

David Sloan, senior economist at 4Cast, is looking for a quarter-point move, but said he is not ruling out a surprise in either direction, putting more risk towards no movement than a half-point cut.

"By some measures, financial markets are looking less tight than a month ago," Sloan said. He noted that panic from Bear Stearns deal has faded, but the interbank market is still tight and mortgage rates haven't come down. "Financial conditions are still far from normal," he added, but the aggressive, alternative measures from the Fed have had some success in providing liquidity to the markets.

Yet even with that relative calm, there is still debate within the FOMC between inflation hawks and those who are concerned the economy could remain weak into the second half of the year, he said, adding that both positions are valid.

However, some analysts still see reason to expect a half-point reduction. Economists from TD Securities said the alternative liquidity measures haven't been as beneficial as initially hoped, opening the door to more accommodation from the FOMC.

"(A)gainst the background of continued signs that the economy is heading for recession, and a tight credit market, there is scope for the Fed to deliver additional stimulus," they wrote in a client note while forecasting a 50 basis point reduction.

In either case, much attention will be given to the accompanying statement, which is expected to imply that the Fed will pause rate cut reductions as the fiscal stimulus package kicks in.

Insofar as inflation remains a top priority, Sloan suggested that fiscal policy measures carry less risk to the U.S. dollar, so the Fed would be wise to step back and observe the results of the tax rebates before making any dramatic moves.

With oil prices at $115 per barrel and the U.S. dollar at $1.55 against the euro, there's plenty of reason to be concerned about the value of the greenback.

However, there will be more room for further reductions in the second half of the year, if needed, Sloan said, even suggesting that a 1% funds rate is not an absolute floor, as often thought.

Liz Miller, managing director at investment management firm Trevor Stewart Burton and Jacobsen Inc, said she expects to see in the statement that the Fed is more concerned with inflation than economic growth right now.

"I think the Fed easing was justified by market turmoil but their most aggressive easing was, from a stock market side, mostly from sentiment and bringing confidence back to investors," she said. "But at the end of the day the Fed's job is to manage monetary policy with an eye for stability and growth."

"The combination of fiscal and monetary stimulus will help this economy achieve a flat to low growth rate for the year," she added. "Whether that is enough to propel the stock markets is anyone's call."

By Patrick McGee, This email address is being protected from spam bots, you need Javascript enabled to view it , edited by Cristina Markham, This email address is being protected from spam bots, you need Javascript enabled to view it