(Recasts, adds reaction, details, prvs NEWPORT NEWS)

By Jason Szep

ENGLEWOOD, Col., Oct 4 - Republican vice presidential nominee Sarah Palin accused Democratic candidate Barack Obama on Saturday of “palling around with terrorists,” in the latest sign the campaign is turning increasingly nasty.

The comment by Palin, whose running mate John McCain is vying against Obama for president in the Nov. 4 election, was dismissed by the Obama campaign as “gutter politics” and came shortly after the McCain campaign had already called the U.S. senator from Illinois a liar.

With polls showing McCain trailing Obama in many battleground states, including several won by Republicans in the 2004 election, Palin said “There is a time when it’s necessary to take the gloves off and that time is right now.”

Speaking at a fund-raiser in Englewood, Colorado, she launched an assault on Obama just days after both candidates urged Congress to set aside partisan politics to pass a $700 billion bad-debt securities package in a bid to free up frozen credit markets.

“Our opponent though is someone who sees America, it seems, as being so imperfect, imperfect enough that he is palling around with terrorists who would target their own country,” Palin said of Obama, also calling him an embarrassment.

Palin cited a New York Times story on Saturday that examined Obama’s relationship with Bill Ayers, a former member of the Vietnam-era militant Weather Underground organization who is now a professor at the University of Illinois at Chicago. The Times concluded they were not close.

Obama spokesman Hari Sevugan said, “Today, the McCain-Palin team took their discredited, dishonorable campaign one desperate step further, announcing that they were going to try ‘turning a page on this financial crisis’ and launching more personal attacks on Senator Obama.”

“Instead of offering solutions for working Americans and families struggling through a failing economy, they have offered more gutter politics and false attacks,” he said in a statement.

Obama served with Ayers on the board of a foundation in Chicago, and has said he was only eight-years-old when the Weather Underground committed its best-known bombing. He has also noted that former President Bill Clinton pardoned two members of the group during the last days of his presidency.

Earlier, McCain’s campaign called Obama a bald-faced liar in reference to how he characterized the Republican’s plan to reform health insurance.

“When you read the fine print, it’s clear that John McCain is pulling an old Washington bait and switch. It’s a shell game,” Obama said of McCain’s plan to reform health insurance.

“He gives you a tax credit with one hand but he raises your taxes with the other,” the senator from Illinois told a crowd of about 18,000 supporters in Newport News, Virginia.

‘BALD-FACED LIE’

McCain spokesman Tucker Bounds shot back, “Barack Obama is lying to voters. ... It’s a bald-faced lie.”

After a week where congressional negotiations over the financial rescue package dominated the campaign, Obama had hoped to use his rally in Virginia to refocus the political discourse on health insurance and economic policy.

Health insurance is an emotive issue, with some 45 million Americans living without coverage and others worried about losing coverage if they lose their jobs in the economic slump.

Both campaigns say they will improve access to health insurance and make care more affordable. On Saturday, both campaigns derided the other’s plan as “radical.”

The sharp exchanges came as the more than year-long campaign enters its last month. New polls show Obama has solidified his national lead and gained an edge in crucial battleground states in recent weeks as the Wall Street crisis focused the attention of voters on the weakening economy.

McCain and Obama will get to spar in person on Tuesday when they meet for the second of three nationally televised presidential debates, this one in Nashville, Tennessee.

Later, at a rally in Carson, California, Palin again said the Republican campaign would become more negative.

“As one of my campaign staffers reminded me as I was walking out, ‘Ok now the heels are on, the gloves come off’,” she told thousand of people at a rally in a sports stadium.

Recent polls show McCain in a dogfight in Ohio, Florida, Virginia, North Carolina, Colorado, Missouri and Indiana. All were won by President George W. Bush in 2004, and McCain cannot afford to lose them as he tries to piece together the 270 electoral votes needed to capture the White House.