Updated from June 12

Since hitting lows in May, all three major stock averages have rallied smartly. But for the momentum to continue into next week, investors will need to see tame inflation data and stability in the price of oil, analysts say.

With a

Federal Reserve

meeting scheduled at the end of this month, investors will be closely monitoring the economic data next week, particularly the inflation numbers for May.

"I think we can waft a little higher," said Dave Briggs, head of equity trading at Federated Investors. "The market is feeling a bit better, but the real wild cards are the PPI and CPI."

The consumer price index on Tuesday is expected to rise 0.4% and the core rate, which excludes food and energy, is projected to increase 0.2%. The producer price index has been delayed indefinitely because of technical reasons.

Briggs said a stronger-than-expected inflation number could renew concerns about a possible 50-basis-point interest rate hike at the end of this month. In a speech this week, Fed Chief Alan Greenspan said the central bank would raise rates at a measured pace, but he noted that it is "prepared to do what is required" if inflation begins to spike higher. The odds of a half-point rate increase remain low at this point, but investors are fully pricing in a quarter-point move.

Monetary fires were fanned over the weekend. On Sunday, Cleveland Fed President Sandra Pianalto said: "I do know this -- the current federal funds rate, at 1%, is too low to be sustainable. Inflation expectations appear reasonably stable right now, but I am concerned about the potential for them to drift up in this environment"

On Friday, Atlanta Fed President Jack Guynn said the FOMC's commitment to "measured" interest rate hikes was more "plan" than pledge.

"When viewed in the historical context and measured in the aggregate, the rate of inflation we are currently seeing appears to be comparable to rates observed just prior to 2001," Guynn said. "In my mind, these are acceptable levels for inflation and fall within my own definition of price stability.

"At the same time, I don't want to dismiss the compelling evidence of rising prices. As I have tried to suggest, a great deal depends on how much of the recent spate of price increases turns out to be transitory. And I would conclude that these recent developments on the price front warrant significant attention in our analysis and policy debates," Guynn said.

Larry Wachtel, senior vice president at Wachovia Securities, agrees that the inflation data could spark worries about a more aggressive rate hike, and he said this could prompt some selling after three weeks of gains. "Once you get that overbought condition, it's hard to press it forward," he said.

The

Dow

has climbed almost 6% since hitting a low in May, while the

S&P 500

has risen 5% and the

Nasdaq

is up more than 7%. For the week, the Dow rose 1.6% to 10,410. The S&P 500 was up 1.2% to 1136, and the Nasdaq gained 1% to just under the 2000 mark.

The recent strength in the market has coincided with some weaker-than-expected economic news. Consumer sentiment surveys have been poor, durable-goods order for April were disappointing, and while the May employment report was generally solid, it wasn't considered strong enough to trigger a 50-basis-point rate increase. Gains in the market have also come amid a decline in oil prices.

"I think that with oil prices coming down from $42 to

$38 a barrel, that's a pretty hefty move, and that may be part of what's behind the rise in the market up to this point," said Paul Nolte, director of investments at Hinsdale Associates. "But the conviction isn't there. I think the jury is still out as to whether the market works higher."

Nolte said that in election years, stocks tend to bottom out from March to August and then rally into year-end. His technical indicators confirm that this pattern may play out.

Meanwhile, Standard & Poor's investment policy committee has recommended that investors take advantage of recent price strength and reduce exposure to domestic and foreign equities by 5 percentage points each while increasing cash holdings. "We believe that even though equities are projected to outperform bonds and cash in the coming months, a rising interest rate environment has also increased the risks associated with owning equities," the firm said in a report.

S&P reduced its year-end target on the S&P 500 to 1210 from 1215, and for the Nasdaq to 2180 from 2225. Those levels would represent a 6.5% increase for the S&P from current levels and a 9% increase for the Nasdaq.

Investors were digesting two economic reports Monday morning. The Commerce Department said retail sales rose 1.2% in May, roughly in line with estimates, while the U.S. trade deficit swelled to $48.33 billion April, up from $46.57 billion in March. The April deficit was a record and easily exceeded economists' forecast of $44.5 billion.

Tuesday will bring the preliminary Michigan consumer sentiment survey for June and business inventories for April. In addition, the Senate Banking Committee is expected to hold a hearing on Greenspan's renomination. On Wednesday, housing starts, the Fed's beige book and industrial production data are on tap, and Thursday will bring the leading economic indicators and Philadelphia Fed survey. The current account balance is scheduled for Friday.

Although economic news, interest rates and oil will prove to be the main focus in the week ahead, a number of companies will be reporting second-quarter earnings.

Oracle

(ORCL) - Get Report

is scheduled to release results on Tuesday along with

Lehman Brothers

(LEH)

and

Circuit City

(CC) - Get Report

.

On Wednesday,

Bear Stearns

(BSC)

is expected to report along with

Best Buy

(BBY) - Get Report

, and

KB Home

(KBH) - Get Report

.

Adobe Systems

(ADBE) - Get Report

and

Red Hat

(RHAT)

will chime in on Thursday.

Expectations for second-quarter earnings growth have risen to 19.5%, while third- and fourth-quarter estimates have also ticked higher. For the year, earnings are now expected to climb by 18.0% compared with 19.3% last year.