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US consumers losing confidence

American consumers slowed their spending pace last month and a key measure of inflation moderated, a report showed on Friday, giving the Federal Reserve leeway to make only modest interest rate hikes to keep inflation in check.

Other economic reports on Friday were mixed, with consumers losing confidence in May as gasoline prices surged and the war in Iraq dragged on. Another report showed business activity surged in the Chicago region.

Personal spending rose 0.3 percent in April, the smallest gain in six months, the Commerce Department said. The figure was in line with forecasts.

More importantly for the economic outlook, incomes rose by a solid 0.6 percent, the biggest gain since last November as the job market improved. The rise showed households will have the wherewithal to keep on spending in the months ahead even if gasoline prices stay high.

A key indicator of inflation in the report -- and the Fed's favored measure of prices -- came in weaker than expected with a 0.1 percent increase, calming worries in the bond market that the Fed would need to make a series of aggressive rate hikes. The annual increase in the core personal consumption expenditures index was a moderate 1.4 percent.

"This eases fears that the Fed was behind the curve," said JP Morgan senior economist Jim Glassman.

"It allows the Fed to go at a measured pace without causing people to worry they are falling behind. The inflation scares are going to be dying down," he said.

Another report on Friday showed US consumer confidence declined in May for a second month in a row, confounding economists' forecasts of a steady reading on sentiment

The University of Michigan's final survey of consumer confidence for May showed its index falling to 90.2, its lowest point since October, from April's final reading of 94.2.

"What's affecting consumer sentiment is the geopolitical news, which is quite negative coming out of Iraq. But also the rise in oil prices is of concern to consumers as it affects their pocketbooks directly and that surely had an impact," said Kevin Logan, senior economist at Dresdner Kleinwort Wasserstein.

But Treasuries investors ignored the two softer-than-expected reports and pushed prices lower after the surprisingly strong survey of Midwestern US manufacturing.

A report on business activity in the Midwest from the National Association of Purchasing Management-Chicago showed a surge to 68.0 this month from 63.9 last month, far above expectations, and the outlook for jobs also improved.

"This confirms the reading on the economy that I have had since the beginning of the year, a mini-boom," said David Littmann, chief economist with Comerica Bank in Detroit.

The income and spending report confirms shoppers were still adding to the American economy at the start of the second quarter after a hefty contribution in the first three months of the year.

JP Morgan's Glassman described the core PCE inflation reading as the "more sober cousin" of the consumer price index, which jumped 0.3 percent last month.

That increase, together with a pickup in employment in March and April, has put the markets on alert for a Fed rate rise in June.

"Inflation is creeping up, but it's not out of hand," said Gary Thayer, chief economist at AG Edwards & Sons.

In a rare move for debt-laden households, the savings rate increased slightly in April to 2.4 percent from 2.2 percent, suggesting consumers may be getting ready for rising rates.

"It is a positive for the long-run health of the economy as it suggests that some consumers may be beginning to prepare for a higher interest rate environment," said Lehman Brothers financial markets economist Drew Matus.
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