Consumer spending falls as sentiment sours

By Lucia Mutikani

WASHINGTON (Reuters) - U.S. consumers cut spending in September and turned gloomier this month, underscoring the fragility of the economy's recovery even as signs emerged that manufacturing may be picking up.

The Commerce Department said on Friday consumer spending fell 0.5 percent last month, the largest drop since December, after a 1.4 percent increase in August. The decline, which was in line with market expectations, followed the end of a government incentive program to boost auto sales.

A separate report showed factory activity in the nation's Midwest expanding for the first time in more than a year, but employment conditions deteriorated. A dismal job market appeared to weigh on consumers, with the Reuters/University of Michigan final index of sentiment for October slipping to 70.6 from 73.5 last month.

The weak consumer data contributed to stocks falling on Wall Street, with the blue chip Dow Jones industrial average index seeing its largest one-day percentage loss since July. Investor mood also soured after an accounting expert projected a $10 billion write-down for Citigroup.

Government bond prices rallied and the U.S. dollar rose, attracting safe-haven flows.

"The irony is consumers are still in a funk even though monthly job losses are shrinking. The economy is in a recovery mode, but it will be a soggy recovery, unless the consumer starts to feel better and spend more," said Cary Leahey, an economist at Decision Economics in New York.

U.S. Federal Reserve policymakers, who meet on Tuesday and Wednesday, are expected to keep their support for the economy in place for some time given labor market slack and muted inflation pressures. The Fed -- the U.S. central bank -- cut overnight interest rates close to zero in December and has held them there ever since.

Government data on Thursday showed the economy grew at a 3.5 percent annual rate in the third quarter, probably ending a recession that began in December 2007.

Much of the expansion was driven by a sharp turnaround in consumer spending, which normally accounts for more than two-thirds of U.S. economic activity.

Spending in the third quarter was bolstered by the popular "cash for clunkers" program, which provided discounts on some new motor vehicle purchases. But that program ended in August, and consumers retrenched last month.

With the labor market still too weak to support domestic demand, there are worries the economy's incipient recovery from the worst recession since the 1930s could wobble once the government support fades.

Billionaire investor George Soros said on Friday economies in the United States and elsewhere were still relying on government support for growth and the risk the global economy reenters recession cannot be ruled out until a self-sustaining recovery takes hold.

SPENDING STILL SEEN GROWING

Analysts said the drop in consumer spending last month should not be interpreted as a sign it will turn negative in this quarter, normally a crucial one for retailers given the end-of-year holiday selling season.

"Consumer spending will probably continue to grow, but at a more subdued pace. After the 3.4 percent real spending growth in the third quarter, we expect consumption growth of 1 percent or less in the fourth quarter," Nigel Gault, chief U.S. economist IHS Global Insight in Lexington, Massachusetts.