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NEW YORK (Reuters) - A big interest-rate cut by the Federal Reserve next week, or at least a hint more cuts are coming, coupled with this week's subprime rescue plan could lift investor confidence and inspire a pre-Christmas rally.
While most investors are banking on a cut of at least a quarter percentage point in the benchmark fed funds rate, many think a deeper reduction is needed to unfreeze credit markets and boost confidence.
On Thursday, President George W. Bush announced a plan to stem U.S. home foreclosures, sending stocks surging on optimism it would keep the economy from sliding into a recession.
"The big focus next week is the Fed meeting," said John Praveen, chief investment strategist at Prudential International Investments Advisers LLC in Newark, New Jersey.
He said that while the market was pricing in an interest- rate cut, there was still speculation about how big such a cut would be and whether the Fed also would cut the discount rate.
"Also if the comments reflect an easing bias, then together with positive momentum on the subprime plan, that should give a good support to equities," he said.
Encouraging data this week, including a resilient payrolls report on Friday, eased some concerns about the economy, decreasing the likelihood of an aggressive 50-basis-point cut in the fed funds rate.
Based on December fed fund futures, the likelihood of a 50- basis-point rate cut stood at 41 percent at midday on Friday, down from 65 percent a week earlier.
The fed funds rate for overnight bank loans now stands at 4.50 percent, following two back-to-back rate cuts -- 25 basis points on October 31 and 50 basis points on September 18.
The discount rate, which is the rate the Fed charges banks for emergency loans, now stands at 5.00 percent, following a 25-basis-point cut on October 31.
For the week, stocks gained, with the blue-chip Dow Jones industrial average .DJI up 1.9 percent, the broad Standard & Poor's 500 Index .SPX up 1.6 percent and the Nasdaq Composite Index .IXIC up 1.7 percent.
And with just a few more weeks left in the year, the Dow is up 9.3 percent so far in 2007. The S&P 500 is up 6.9 percent for the year to date, and the Nasdaq is up 12 percent.
While investors are primarily focusing on a potential rate cut on Tuesday, they will also be closely watching inflation data later in the week.
The Labor Department will release its Producer Price Index for November on Thursday, and the Consumer Price Index is due on Friday. The consensus forecast is for an increase of 1.5 percent in overall PPI and a 0.2 percent gain in core PPI, which factors out volatile food and energy prices.
The overall CPI is expected to rise 0.6 percent, while core CPI is forecast to gain 0.2 percent.
"If the Fed cuts rates on Tuesday, then a stronger-than-expected CPI or PPI could challenge the wisdom of the cut,"said Tom Sowanick, chief investment officer of Clearbrook Financial LLC in Princeton, New Jersey.
Financials will stay in focus, as Lehman Brothers LEH.N kicks off the fourth-quarter earnings season for investment banks and brokers on Thursday, and with investors braced for more news of subprime write-downs.
"We'll be focusing on analysts cutting their earnings estimates for 2008 and the size of the write-down that will be taken by money-center banks," said Joseph Battipaglia, market strategist at Stifel Nicolaus in Philadelphia.
"They've already done it for the financials. They will start doing it for the economically sensitive sectors."
In addition, four blue-chip U.S. industrial heavyweights are expected to spell out their financial expectations for 2008 next week.
Investors and analysts who follow General Electric Co (GE.N), United Technologies Corp (UTX.N), 3M Co (MMM.N) and Honeywell International Inc (HON.N) said they are expecting the slowing U.S. economy to take a toll on revenue growth and will be listening closely for signs of how companies plan to meet their goals for profit growth in light of that.
Manufacturers are facing economic headwinds, including the slumping U.S. housing market, a credit crunch and high energy and commodity costs.
U.S. crude oil futures CLc1 settled on Friday at $88.28 a barrel, after rising back above $90 this week following OPEC's decision to leave production quotas in place.
Monthly data from the Commerce Department, due on Thursday, could also move the market, given concerns about consumer spending, Praveen said.
Retail sales are expected to have risen 0.6 percent in November, at the start of the holiday shopping season, up from a 0.2 percent gain in October, according to the consensus forecast of economists polled by Reuters.
Other economic data scheduled for next week includes pending home sales for October on Monday, which if very weak, would add to calls for a big rate cut on Tuesday. They are expected to fall 1 percent.
Industrial production for November is due on Friday. An increase of 0.1 percent is forecast, an improvement from October's reading of -0.5. Capacity utilization is seen holding steady at 81.7 percent.
(Wall St Week Ahead runs weekly. Questions or comments on this column can be e-mailed to kristina.cooke(at)reuters.com.
(Additional reporting by Jennifer Ablan and Jennifer Coogan;
Editing by Jan Paschal )