msnbc.com news services
updated 7/31/2006 9:05:57 AM ET 2006-07-31T13:05:57

Evidence of a moderating economy helped Wall Street to mount a strong rally Friday, as a sharp slowdown in economic growth fed hopes for an end to rising interest rates. The Dow Jones industrial average saw its best weekly gain since May 2005.

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Investors bid shares higher after the Commerce Department said GDP growth tailed off by more than half to a 2.5 percent annual rate. Although the reading was weaker than forecast, the pace was considered healthy and reinforced beliefs that the Federal Reserve may not need to hike interest rates further.

“There are still signs of inflation out there, but the [GDP report] was weak enough to convince people that the Fed will have to pause,” said Marc Pado, U.S. market strategist at Cantor Fitzgerald & Co. in San Francisco. “That’s what opened the door for the broad-based advance.”

Wall Street’s optimism overcame signs of soaring inflation and lower consumer confidence. Core consumer prices — excluding energy and food — surged 2.9 percent last quarter, while employment costs rose a stronger-than-expected 0.9 percent.

While investors have been spooked by any hint of rising prices, they likely set aside the GDP’s inflation component because recent reports have shown a more benign trend, said Jeff Kleintop, chief investment strategist for PNC Financial Services Group.

The Dow Jones industrial average finished the day up 119.27 points, or 1.07 percent, having closed Thursday little changed since soaring 230 points on Monday and Tuesday. Friday’s rally capped the Dow’s best weekly gain since May 2005.

The broader Standard & Poor’s 500-stock index closed Friday up 15.35 points, or 1.22 percent, chalking up its best weekly gain since November 2004, while the Nasdaq composite index jumped 39.67 points, or 1.93 percent, to post its best weekly gain since January.

For the week, the Dow rose 3.23 percent, the S&P 500 gained 3.08 percent and the Nasdaq composite advanced 3.65 percent.

Crude oil prices fell , as energy traders took profits from recent gains on worries about political tension in the Middle East and Nigeria.

Investors moved cautiously this week ahead of Friday’s economic news, and analysts say listless trading should continue until the Fed’s Aug. 8 meeting on interest rates. With oil lingering at persistently high levels, investors have been nervous about the Fed’s ability to set rates where they will curb inflation but preserve economic growth.

GDP growth was expected to slow from a brisk 5.6 percent annual rate in the first quarter, but the number came in below economists’ forecast of 3 percent.

Although the Commerce Department’s employment cost index topped estimates for an 0.8 percent increase, Kleintop said investors perhaps were more focused on the longer-term downward trend in the amount companies were paying for employee benefits.

The University of Michigan’s consumer sentiment index for July lost 0.2 points to 84.7. However, the report also showed Americans were increasingly upbeat about the economic outlook despite high gasoline prices and lending costs.

Wal-Mart Stores Inc. gained on news that the discount retailer plans to sell its 85 stores in Germany to Metro AG. Wal-Mart rose 93 cents to $44.46.

Chevron Corp. posted its best-ever quarterly profit , which rose 18 percent but fell short of Wall Street estimates. Its earnings capped a round of stellar results from oil companies. Chevron lost $1.68 to $66.05.

Oil services company Baker Hughes Inc. also saw its earnings skyrocket from the sale of its stake in WesternGeco. Baker Hughes nonetheless fell $2.95 to $77.90.

Overseas, Japan’s Nikkei stock average added 1.07 percent. Britain’s FTSE 100 rose 0.77 percent, Germany’s DAX index gained 0.82 percent and France’s CAC-40 added 0.55 percent.

The Associated Press and Reuters contributed to this report.

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