The stock market strengthened last week after evidence of a slowing economy assuaged fears of further rate hikes, but lingering signs of inflation challenged the view that the Federal Reserve will halt its tightening campaign in August.

As a result, investors were left waiting for confirmation in the coming week that the monetary gods can answer their prayers for a soft landing.

Employment data, a monthly report from the Fed and a weaker-than-expected reading on GDP growth have all combined recently to bolster the case for what many investors have suspected: U.S. growth is slowing.

On Friday, the Commerce Department said GDP grew in the second quarter at an annual rate of just 2.5%, marking a sharp slowdown from the 5.6% pace set in the previous quarter. These days, investors welcome such news as a signal that the central bank can stop worrying about inflation and quit making credit more expensive by raising interest rates.

Following the report, the S&P 500 rallied up 1.2% to cap a 3.1% gain for the week. Still, stocks are below their May highs, and the recent optimism is guarded because inflationary data hasn't disappeared.

The GDP report showed that core prices, an important gauge of inflation that excludes food and energy-related products, jumped in the quarter to a 2.9% annual rate. That figure, an increase from 2.1% in the first quarter, strays far outside the Fed's stated comfort zone of 2%, and it represents the highest reading since the third quarter of 1994. However, it's important to remember that the core-prices number refers to a period that ended in June, so it's viewed as a lagging indicator rather than a harbinger of things to come.

Like the last monthly employment report from the Labor Department, the GDP report contained hints of a worst-case scenario in which the U.S. revisits the stagflation nightmare of the 1970's with the economy slowed and inflation spiraling.

For June, the Labor Department said the economy added just 121,000 nonfarm new jobs, well short of expectations. Meanwhile, average hourly earnings rose 0.5%, compared with the 0.1% increase recorded in May. Economists were expecting a tick up to 0.3%, and the strong reading was widely viewed as another sign that inflation remains a danger.

The coming week brings the July employment report on Friday, and expectations have been reined in. Economists are anticipating 145,000 new jobs from the closely watched payroll survey, and average hourly earnings are expected to moderate to an increase of 0.3%.

Mitigating wage pressure could free the Fed to take a pause in August and let investors breathe easier. A light reading on Tuesday's personal spending report from the Commerce Department could do the same. Economists are expecting personal incomes to have risen in June by 0.7%, while personal consumption gained 0.4%. The core inflation gauge in the report is forecast to show a monthly gain of 0.2%.

"Anything above that could stoke fears of inflation again," says Nick Raich, director of research with National City Private Client Group. " Fed Chairman Ben Bernanke will be watching that report for any worrisome signs."

While macroeconomic data may show a slowing economy, corporate profits are revealing no signs of a slowdown. With 65% of companies in the S&P 500 having provided their quarterly results, Thomson Financial reports that overall earnings growth for the index is now expected to be up 14.8% for the quarter. At the beginning of the reporting season, analysts were looking for 11% growth, and the uptick reflects the 223 companies that have beat analysts' projections. Just 54 have missed estimates; 45 others matched.

Meanwhile, the double-digit gains are now seen lasting for the rest of 2006, extending an extraordinary period of robust profit growth for corporate America. "Expectations for the future have been good this time around overall," says David Dropsey, a research analyst with Thomson First Call.

Only two components of the Dow Jones Industrial Average are slated to report results next week. Analysts are expecting Verizon ( VZ), due out on Tuesday, to post an operating profit of 62 cents a share. That would mark a decline from the 63 cents a share it recorded for the same period last year.

On Wednesday, Procter & Gamble ( PG) is expected to report an operating profit of 54 cents a share, down from last year's 56 cents.

Starbucks ( SBUX) will also report its earnings Wednesday, followed by KeySpan ( KSE) and Sprint ( S) on Thursday, and Toyota ( TM) and British Airways ( BAB) on Friday.

In total, 87 companies from the S&P will report next week. Richard Peterson, research analyst with Thomson Financial, says investors can also expect the rash of merger and acquisition activity to continue for the rest of the year.

Last week saw history's largest leveraged buyout ever, a $33 billion bid for hospital operator HCA ( HCA) from Bain Capital, Kohlberg Kravitz Roberts and Merrill Lynch ( MER). The takeover amount surpassed KKR's $30 billion deal for RJR Nabisco in 1989.

Judging by the vast sums of money held in private equity coffers these days, Peterson says investors probably won't have to wait another 17 years for a new record.

"I don't know if it will take 18 months even," says Peterson. His research notes that the U.S. takeover market is closing in on the $800 billion mark in announced deals for 2006, which means it could surpass the 2005 total of $1.1 trillion before the end of the summer. "Look for more big deals coming real soon," he says.