Data signal soft economy but not abrupt slowdown

A woman goes down an escalator at a Toys R Us store in New York, December 14, 2010.

WASHINGTON (Reuters) - U.S. consumer spending fell in April for the first time in almost a year and already low inflation declined further, undercutting arguments for a near-term tapering of the Federal Reserve's bond-buying stimulus.

Despite the pullback in consumer spending, the economy is not slowing abruptly. Consumer sentiment approached a six-year high in May and factory activity in the Midwest regained speed this month, other data showed on Friday.

While this suggests the economy may be squeezing out of a soft patch hit early in the second quarter, the limited show of strength is unlikely to convince the U.S. central bank to start scaling back the $85 billion in bonds it is buying each month.

"Any enthusiasm to slow the pace of bond purchases before the end of the summer will likely be tempered at the margin, particularly given the benign inflationary backdrop," said Millan Mulraine, a senior economist at TD Securities in New York.

Consumer spending fell 0.2 percent, the weakest reading since May last year, the Commerce Department said. When adjusted for inflation, spending nudged up 0.1 percent.

The sixth straight month of gains in the so-called real consumer spending reflected a 0.3 percent decline in a price index for consumer outlays. It was the second straight monthly decline in the index and the largest drop since July last year.

Over the past 12 months, inflation has slowed to just 0.7 percent, the smallest gain since October 2009 and well below the Fed's 2 percent target. The price index had increased 1 percent in the period through March.

A core price index, which strips out food and energy costs, was up 1.1 percent in the past 12 months, compared with a 1.2 percent rise in March. The Fed watches this index closely to try to gauge inflation trends.

Fed Chairman Ben Bernanke said last week the central bank could decide to start tapering its bond purchases at one of its "next few meetings" if the economy appeared set to maintain momentum.

But analysts said Bernanke would likely be reluctant to do so if inflation did not look to be picking up.

"I suspect that if inflation readings remain very low it's going to make him want to keep on purchasing at the current pace," said Michael Schumacher, head of global rates strategy at UBS in Stamford, Connecticut.

RESILIENT ECONOMY

Some economists cut their already low second-quarter growth forecasts on the soft spending data.

Nevertheless, they said the economy was largely holding its own in the face of belt-tightening in Washington as the government tries to cut its budget deficit. Growth is being supported by rising house and share prices, as well as steady gains in employment, which are lifting household spirits.

The final reading on the Thomson Reuters/University of Michigan's index on consumer sentiment rose to 84.5 from 76.4 in April. It was the highest level since July 2007.

Manufacturing is also showing tentative signs of regaining its footing, after being shaken by tighter fiscal policy.

The Institute for Supply Management-Chicago business barometer rose to 58.7 from 49 in April. A reading above 50 indicates expansion in the regional economy.

The gains were driven by a pickup in new orders, a jump in an employment measure, supplier deliveries and unfilled orders. Inventories also fell, a good sign for the region's factories.

The survey correlates closely to the national Institute for Supply Management manufacturing index. The ISM will publish its national factory survey on Monday.

"The rebound in order growth, employment growth, order backlogs and production, while continuing to liquidate inventory at a rapid pace, suggests that manufacturing conditions improved significantly in the month," said John Ryding, chief economist at RDQ Economics in New York.

Though consumer spending fell last month, it was mainly held down by weak demand for utilities and a drop in receipts at gasoline stations on the back of a fall in prices at the pump. Spending on durable goods increased 0.4 percent, before adjusting for the drop in inflation.

"Real spending is soft, but enough to help carry the economy forward," said Ryan Sweet, a senior economist at Moody's Analytics in West Chester Pennsylvania. "We need the consumer to continue spending because there are not many legs to stand on."

Consumer spending, which accounts for about 70 percent of U.S. economic activity, grew at a 3.4 percent annual rate in the first quarter. That helped push economic growth ahead at a 2.4 percent pace.

But lack of income growth against the backdrop of modest job gains could restrain consumer spending. Income was flat in April and the saving rate was unchanged at 2.5 percent.

"A low 2.5 percent personal savings rate gives the consumer little cushion to sustain spending in the face of unexpected adverse shocks," said Scott Anderson, chief economist at the Bank of the West in San Francisco.

(Reporting by Lucia Mutikani; Additional reporting by Leah Schnurr, Richard Leong and Karey Brettell in New York; Editing by Neil Stempleman)