U.S. Economy: Consumer Spending Slows, Inflation Accelerates

By Shobhana Chandra

Aug. 29 (Bloomberg) -- Spending by U.S. consumers slowed in July as the impact of the tax rebates faded and a pickup in inflation eroded Americans' buying power.

Purchases rose 0.2 percent, one-third the pace in June, the Commerce Department said today in Washington, while prices surged the most in 17 years. The Reuters/University of Michigan final index of consumer sentiment was at 63 this month, from 61.2 in July.

The figures on spending, which accounts for more than two- thirds of the economy, underscore projections for growth to slow from the 3.3 percent pace last quarter that the government reported yesterday. With unemployment rising and home values dropping, Americans are cutting back on big-ticket items like automobiles and furniture, today's report showed. Stocks fell.

``We are looking for a clear slowdown in the economy,'' said Nigel Gault, chief U.S. economist at Global Insight Inc. in Lexington, Massachusetts, who accurately forecast the gain in spending. ``Inflation has been eating into spending power.''

The Standard & Poor's 500 Stock Index dropped 1 percent to 1,287.57 at 11:00 a.m. in New York. Treasuries also slipped, with yields on benchmark 10-year notes at 3.80 percent, compared with yesterday's close of 3.78 percent.

A separate private report indicated business activity advanced in August as commodity prices retreated from record levels. The National Association of Purchasing Management-Chicago said its business index increased to 57.9 from 50.8. Fifty is the dividing line between expansion and contraction.

Economists' Forecasts

The increase in spending matched the median forecast of 75 economists in a Bloomberg News survey.

Incomes dropped 0.7 percent, the first decrease since August 2005, reflecting the end of the rebates, after a 0.1 percent gain the prior month. The median projection was a decline of 0.2 percent.

As domestic demand wanes, the U.S. may also be hit by a slowdown in economies abroad that would erode export gains. Europeans' confidence fell more than forecast this month as the economy teetered on the brink of a recession, a report showed today. The European Commission's index of executive and consumer sentiment dropped to 88.8 from 89.5 in July.

The Commerce Department report's price gauge tied to spending patterns jumped 4.5 percent from July 2007, the biggest 12-month gain since 1991.

Fed Forecast

The Federal Reserve's preferred gauge of prices, which excludes food and fuel, climbed 0.3 percent for a second month. The so-called core price measure was up 2.4 percent from a year before, the most since February 2007. That compares with the 1.8 percent to 2 percent median forecast of Fed officials for 2010, which is an indication of their target for the measure.

Adjusted for inflation, spending plunged 0.4 percent, the biggest drop in four years. Price-adjusted purchases of durable goods, such as autos, furniture, and other long-lasting items, dropped 1.6 percent. Spending on non-durable goods decreased 0.9 percent, and services, which account for almost 60 percent of all outlays, were unchanged.

Concern over both slower growth and rising prices led Fed policy makers to hold the benchmark interest rate at 2 percent this month.

Rising unemployment, falling stock and house prices and stricter lending rules ``were viewed as pointing towards weak growth in personal consumption expenditures during the second half of 2008,'' minutes of the Fed's Aug. 5 meeting released this week showed.

Savings Rate

The drop in incomes pushed the savings rate down to 1.2 percent from 2.5 percent the prior month.

Disposable income, or the money left over after taxes, decreased 1.1 percent. Adjusted for inflation, it fell 1.7 percent after declining 2.6 percent in June.

Other reports indicate purchases of big-ticket items are weakening. Sales of autos and light trucks plunged in July to a 12.5 million annual pace, the lowest since 1993, according to Bloomberg calculations based on industry data.

The real-estate slump in also hurting purchases of household goods. Williams-Sonoma Inc., the biggest U.S. gourmet-cookware chain, said yesterday that second-quarter earnings dropped 29 percent and reduced its annual sales forecast.

Weakening trends continued through August and are worst in cities most affected by the housing slump, Chief Executive Officer Howard Lester said on a conference call. At Pottery Barn and West Elm, for example, purchases have suffered in Southern California, Nevada and south Florida, he said.

``It is extremely difficult to know how the consumer will respond in the back half of the year,'' Lester said in a statement. ``We are also looking forward to 2009 with a very cautious outlook.''

The longest expansion in consumer spending on record will probably end this year, according to economists surveyed by Bloomberg earlier this month. Retail sales fell in July for the first time in five months, led by a slump in auto purchases, according to Commerce data.