By Lucia Mutikani
WASHINGTON (Reuters) - U.S. households stretched to pay for costlier gasoline on meager income growth in August, undercutting spending on other items and pointing to lackluster economic growth.
Other data on Friday showed factory activity in the Midwest contracted this month for the first time in three years.
The Commerce Department said consumer spending rose 0.5 percent last month after gaining 0.4 percent in July. The increase was the largest in six months, but it reflected a rise in gasoline costs that pushed inflation up by the most in nearly 1-1/2 years.
Adjusting for the jump in prices, spending edged up a scant 0.1 percent. With inflation wiping out their buying power, consumers curbed their saving to fund purchases -- a potentially bad omen for future spending.
"Consumers are supporting the recovery, but they are just not able to lead it because of the soft jobs market and little income. They are running low on fire power," said Ryan Sweet, a senior economist at Moody's Analytics in West Chester, Pennsylvania.
Income ticked up 0.1 percent but was down 0.3 percent after accounting for inflation and taxes. It was the first decline in real disposable income since November.
With inflation-adjusted spending barely rising last month, real consumer spending, which accounts for about 70 percent of U.S. economic activity, is unlikely to grow much more than the tepid 1.5 percent annual pace recorded in the April-June period.
Walgreen Co, the largest U.S. drugstore chain, posted a lower quarterly profit on Friday and said it had faced a challenging year in which consumers cut back on everyday purchases. At stores open at least a year, sales fell 8.7 percent in Walgreen's latest quarter.
FACTORIES LOSING STEAM
Separately, the Institute for Supply Management-Chicago said its Midwest factory barometer found activity contracted this month for the first time since September 2009, reflecting weak new orders and a slowdown in hiring.
It was consistent with other recent reports flagging a cooling in manufacturing, a sector that had been the pillar of the economy's recovery.
"To the extent that the moderation in manufacturing activity is reflecting weakening domestic and global demand, it may be a harbinger of continued sup-par GDP growth," said Millan Mulraine, a senior economist at TD Securities in New York.
But households appear little perturbed by the gathering dark clouds. Consumer confidence touched a four-month high in September, boosted by higher stock market prices and gains in home values. That resilience could be a boost to President Barack Obama as he seeks a second term in November.
Economists, however, cautioned that household morale could sour towards the end of the year if the U.S. Congress fails to avoid the so-called fiscal cliff -- $600 billion or so in expiring tax cuts and government spending reductions set to take hold in 2013.
The mixed data sent U.S. stocks lower. However, Wall Street recorded its best third quarter since 2010. Prices for U.S. Treasury debt pushed higher, supported by doubts over the chances for success of debt-ridden Spain's 2013 budget. The dollar rose against the euro, advancing for a second straight week.
TROUBLE GAINING STEAM
Slower consumer spending and a drop in farm inventories due to a severe drought in the Midwest held gross domestic product growth to a 1.3 percent pace in the second quarter, a step down from 2 percent in the first three months of the year.
Growth estimates for the third quarter range from 1.2 percent to 2.1 percent. Spending last month was funded by cutting back on saving, which economists said put households on shaky ground, particularly if income taxes go up in January.
"It highlights how imperative it is that Congress deals with this issue. This is not an economy that can bear the burden of fiscal tightening right now," said Julia Coronado, chief North America economist at BNP Paribas in New York.
Inflation pressures picked up last month on the back of the 28.2 cents per gallon rise in gasoline prices. A price index for personal spending increased 0.4 percent, the largest rise since March last year, taking the 12-month gain up to 1.5 percent from 1.3 percent in July.
However, a measure which strips out food and energy costs, rose only 0.1 percent from July. Year-on-year that core measure was up 1.6 percent, the same as in July and the fifth straight month of increases below 2 percent.
The Federal Reserve has a 2 percent inflation target and the still-moderate pace of inflation should give it comfort to maintain its accommodative monetary policy stance for a while as it seeks to spur job growth and domestic demand.
(Additional reporting by Jessica Wohl in Chicago; Editing by Tim Ahmann and Kenneth Barry)