updated 6/29/2007 12:11:05 PM ET 2007-06-29T16:11:05

Consumers boosted their spending in May as their incomes grew solidly, an encouraging sign that high gasoline prices haven’t killed people’s appetite to buy. Inflation moderated.

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It was the second month in a row that consumer spending went up 0.5 percent, the Commerce Department reported on Friday.

Incomes, the fuel for future spending, rebounded in May, growing 0.4 percent. That was an improvement from the 0.2 percent drop reported for April.

In other economic news, construction spending rose 0.9 percent in May, the biggest gain in nearly 1 1/2 years, the department said in a second report. Brisk spending on big government projects, such as hospitals and other health care facilities, and by private builders on commercial construction, such as office buildings, eclipsed continued weakness in the housing sector.

Construction spending was stronger than the 0.2 percent gain economists were calling for. The levels of spending by the government for public projects climbed to $284.5 billion in May and spending by private builders for nonresidential construction grew to $343.1 billion — both were all-time highs.

The latest snapshot of consumer behavior, however, was a bit weaker than economists were expecting. They were forecasting consumer spending to rise 0.7 percent and for incomes to grow 0.6 percent in May. The spending and income figures aren’t adjusted for inflation.

On Wall Street, the latest batch of economic reports gave stocks a lift. They supported the notion that the economy is picking up speed — but not too much. The Dow Jones industrials were up around 70 points in morning trading.

Consumer spending plays a major role in shaping overall economic activity. In the first three months of this year, it was consumers’ brisk spending that kept the national economy from stalling. Going forward, though, buyers are expected to be more subdued. In fact, when adjusted for inflation, consumer spending nudged up only 0.1 percent in May, following a 0.2 percent increase in April.

“Sharply higher gasoline prices left a lot less extra jingle in consumers’ pockets to spend on other items,” said Stuart Hoffman, chief economist at PNC Financial Services Group.

The economy barely moved in the first quarter, growing at a pace of just 0.7 percent, the weakest in more than four years. A rebound in the April-to-June quarter is anticipated, with growth coming in anywhere from a pace of 2.3 percent to around 3 percent.

Growth in the second quarter is expected to be mostly powered by a revival of business investment. Friday’s construction spending report boded well on that front. Belt tightening by businesses worried about the severity of the housing slump was a big factor behind the first-quarter’s economic slowdown.

In deciding to hold interest rates steady on Thursday, Federal Reserve Chairman Ben Bernanke and his central bank colleagues also stuck to their forecast that economic activity would bounce back modestly in the coming quarters. The Fed’s key rate has stood at 5.25 percent since last June, giving borrowers a yearlong period of rate stability. Rate predictability can be helpful when mapping out big-ticket purchases and investment decisions.

An inflation measure tied to the income and spending report showed “core” prices — excluding food and energy — moderated. These prices rose 1.9 percent over the last 12 months ending in May. That was the best annual showing since the spring of 2004.

Even so, Bernanke and his colleagues made clear Thursday that they are not ready to declare victory against inflation and will be watching for sustained improvements. The biggest risk to the economy, they said, is if inflation fails to recede as they anticipate.

In May, consumers rediscovered their appetite to spend on big-ticket durable goods, such as cars and appliances. This spending rose 0.4 percent, compared with a 0.6 percent decline in April. Spending on nondurables, such as food and clothes, went up a brisk 1.4 percent in May, up from a 0.5 percent gain in April. Spending on services edged up 0.1 percent in May, down from a 0.8 percent rise in the prior month.

With spending outpacing income growth, Americans’ personal savings rate — savings as a percentage of after-tax income — fell to negative 1.4 percent in May, the worst showing since August 2006.

Economists, however, caution that the picture of savings isn’t as bad as it looks. The savings rate doesn’t provide a complete picture of household finances because it doesn’t capture gains from such things as real estate or financial investments.

Copyright 2007 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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