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While I would certainly assume that Y! is gathering this information for other uses (why would they not?), I don't know of a current example of them using this in their search results.
To demonstrate-- do a search for the word 'plumber' then a search for 'plumber city, state'. Only the latter will trigger localized results (it should be noted, for some major metros tested the phrase ordering 'city keyword' resulted in local results, but these seem to be hand-picked by Y! and don't work for most terms/cities).
As far as I know, Y! is still matching known cities, neighborhoods and zip codes to the radius selected by advertisers, and matching to the geoqualified search phrases that occur (in the proper format).