Consumer spending shrinks but confidence rises

By Mark Felsenthal

WASHINGTON (Reuters) - Personal income tumbled unexpectedly in July and inflation-adjusted spending shrank as government economic stimulus waned, but consumer spirits rose this month, a hint the economy may muddle through its woes.

Personal income fell 0.7 percent in July, the sharpest decline since a 2.3 percent plunge in August 2005, when Hurricane Katrina hit, the Commerce Department said on Friday. Analysts were expecting income to hold steady.

At the same time, a big jump in prices pushed inflation to a 17-year high, eroding what little spending power consumers had. Consumer spending, which accounts for about two-thirds of economic activity, rose 0.2 percent as expected, the slimmest gain since February, and inflation-adjusted spending fell by 0.4 percent, the biggest drop since June 2004 and the second straight monthly decline.

Consumer confidence hits its highest in five months in August, however, posting an unexpectedly large recovery from depressed levels with the help of moderating energy prices.

The Reuters/University of Michigan Surveys of Consumers said its final index of confidence for August rose to 63.0, its highest since March, from 61.2 in July.

"Consumers are certainly worried about the job and housing markets but lower gasoline prices have given them some tangible relief and we are seeing that relief expressed in the various consumer confidence figures," said Lynn Reaser, chief economist at Bank of America Capital Management in Boston.

The unexpectedly weak income and spending data combined with a jump in oil prices and disappointing earnings to drive stock prices down. In late morning, the blue chip Dow Jones industrial average was off more than 1 percent.

Prices for U.S. government bonds, which react negatively to inflation, moved lower, while the dollar held steady versus the euro but slipped against the yen.

STIMULUS FADING

"With the tax refund effect on spending now more or less over, we think the worst is yet to come for consumers," said Ian Shepherdson, an economist with High Frequency Economics in Valhalla, New York.

The government issued $13.7 billion stimulus checks to U.S. households last month -- about half of the amount sent out in June. By the end of July, $90 billion had been delivered as part of the effort to put an extra $107 billion in consumers' hands this year.

Consumer prices rose by a sharp 0.6 percent last month, pushing the year-on-year rise in the personal consumption expenditures price index up to 4.5 percent, the highest since February 1991.

Much of the increase was due to fast rising food and energy prices. But even with those costs stripped out, prices gained 0.3 percent from June and were up 2.4 percent over the past year, the biggest annual gain since February 2007.

Other reports showed that business activity in the Midwest expanded in August at a stronger rate than expected as new orders jumped, while New York City's economy shrank for a third straight month.

The Institute for Supply Management-Chicago business barometer surged to 57.9 in August from 50.8 in July. Economists had forecast the index at 50.0, straddling the line between expansion and contraction.