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A customer shops at a Walmart Supercenter in Rogers, Arkansas June 6, 2013. (Reuters/Rick Wilking)

Weak spending, inflation data underscore soft U.S. economy

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WASHINGTON (Reuters) - U.S. consumer spending barely rose and inflation was tame in July, offering a cautionary note on the economy as the Federal Reserve weighs cutting back its massive bond-buying program.

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Spending, which accounts for more than two-thirds of U.S. economic activity, will likely struggle to regain momentum as other data on Friday showed consumer sentiment fell this month.

The reports added to a raft of data that have suggested a loss of steam in the economy early in the third quarter.

"No second-half acceleration (in economic growth), just more of the same," said Michelle Girard, chief economist at RBS in Stamford, Connecticut.

Consumer spending ticked up 0.1 percent, restrained by weak outlays on utilities, the Commerce Department said. Spending, which had increased 0.6 percent in June, was also held back last month by tepid income growth.

Economists polled by Reuters had expected consumer spending to gain 0.3 percent last month.

Separately, the Thomson Reuters/University of Michigan's final reading on the overall index on consumer sentiment slipped to 82.1 in August from 85.1 in July as households worried about higher interest rates and slower economic growth.

Long-term interest rates have risen by more than a full percentage point over the last three months on the view that the Fed will start scaling back as soon as next month its hefty support for the economy.

Though sentiment remains relatively high, the pullback last month is a potential sign that consumer spending will probably not pick up that much in the coming months, in the absence of a strong gains in income growth.

The tepid demand dampened inflation pressures last month. A price index for consumer spending edged up 0.1 percent, slowing from a 0.4 percent increase in June. Over the past 12 months, prices rose 1.4 percent compared with 1.3 percent in June.

It was the biggest increase since February.

Excluding food and energy, the price index for consumer spending nudged up 0.1 percent after advancing 0.2 percent in June. Core prices were up 1.2 percent from a year ago, rising by the same margin for a fourth consecutive month.

INFLATION BELOW TARGET

Both inflation measures continue to trend below the Fed's 2 percent target. That, combined with the lackluster consumer spending, would argue against the U.S. central bank trimming the $85 billion in bond purchases it is making each month to keep interest rates low.

Many economists, however, believe the Fed will make an announcement on the tapering at its September 17-18 policy meeting, starting off with a small cut to the bond-buying program, known as quantitative easing.

"This does nothing to alter our view of tapering," said Eric Green, chief economist at TD Securities in New York. "Fear of unquantifiable financial risks within a QE regime that offers diminishing returns is driving the policy agenda, not strong growth and inflation."

Stocks on Wall Street were lower, while U.S. Treasury debt prices rose. The dollar slipped against the yen, but was up against the euro.

Consumer spending last month adjusted for inflation was flat after rising 0.2 percent in June.

The unchanged reading in the so-called real consumer spending, which goes into the calculation of gross domestic product, added to data on residential construction, durable goods orders, industrial production and new home sales that have suggested the economy got off to a slow start this quarter.

The economy grew at a 2.5 percent annual pace in the second quarter, accelerating from a 1.1 percent rate in the first three months of the year.

Forecasting firm Macroeconomic Advisers lowered its third-quarter GDP growth estimate by two tenths of a percentage point to a 1.6 percent rate on the weak spending data. RBS cut its GDP growth forecast to 1.5 percent from 2.0 percent. Barclays now sees growth at 1.6 percent instead of 1.9 percent.

Consumer spending rose at a 1.8 percent rate in the April-June period. It continues to be constrained by a sluggish wage growth. Last month, income ticked up 0.1 percent after rising 0.3 percent in June.

The weak wage growth was flagged in the July employment report, which showed a drop in hours worked and hourly earnings.

Both private and government salaries fell last month. Furloughs at federal government agencies as part of Washington's belt-tightening to cut the budget deficit reduced salaries by $7.7 billion last month.

With spending matching income growth, the saving rate - the percentage of disposable income households are socking away - held at 4.4 percent.

But there is room to be cautiously optimistic. A third report showed factory activity in the country's Midwest expanded in August as new orders pushed higher. However, a gauge of factory employment slipped.

(Reporting by Lucia Mutikani, additional reporting by Steven C Johnson in New York; Editing by Andrea Ricci)

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