Well, let me start with the usual disclaimer of "I'm not a doctor, nor do I play one on TV".
Perhaps your body took the sudden reduction in calories to mean "go into starvation mode and hang on to every last pound you can". Perhaps you are eating very different things that are causing you to retain water. Also, more info would probably help wiser heads than my own: what are you eating and when, are you exercising (cardio or weights or neither), are you on or near that time of the month, are you increasing your water intake, and what was your activity level before the start of diet vs now...??
Just as an example, here's the mistake I made. I started in January, thinking I was doing well, weight of 275. I stayed at 275 for a solid month. Toward the end of January I visited with my doctor and discussed what I was doing. Talking with her made me realize that I was lying to myself. I was eating smaller portions, better choices, and no dessert... but I wasn't really exercising and I was still eating some high sodium stuff and retaining water. I thought my portion sizes were "better" but they were really still a little too much. I was snacking too much on "good" stuff, like popcorn - with lots of salt. My "walks" were more like "crawls"; didn't get my heart rate up, didn't even break a sweat most of the time.
I do understand how frustrating it is. For that first month I really thought that I was just stuck and would never lose another pound again, that I had really finally screwed myself and my metabolism to the point that I would have no choice but to turn to The Surgery, which I am pretty frightened of. But I kept coming to my support boards and kept learning and kept getting motivated to keep exercising, and now I'm starting to see some results... only 12 pounds in 8 weeks, mind you, but it's 12 pounds less than I could be!
Good luck and please don't give up!
-Lala