updated 9/28/2007 8:55:17 AM ET 2007-09-28T12:55:17

Consumers shrugged off a rash of bad news to spend more than expected in August while a key measure of inflation eased to the slowest pace in 3½ years.

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The Commerce Department reported Friday that consumer spending rose by 0.6 percent in August, the best showing in four months and better than the 0.4 percent increase that had been expected. Incomes rose by 0.3 percent last month, slightly lower than had been expected.

A closely watched gauge of inflation was up just 1.8 percent in August, compared to the same period a year ago, the smallest increase since a similar rise in February 2004.

The strength in consumer spending should bolster confidence that the economy will be able to withstand the blows it has been receiving from the worst housing slump in 16 years, a serious credit crunch and an unexpected loss of jobs in August. Consumer spending accounts for two-thirds of total economic activity.

The Federal Reserve last week cut a key interest rate by one-half point, a bigger drop than had been expected, in an effort to make sure that the housing and credit problems don’t push the country into a recession.

Analysts are hoping that rate cut will be just the first in a series of reductions as falling inflation pressures give the central bank the leeway to focus on weakening growth.

The 1.8 percent rise in core inflation over the past 12 months, which excluded energy and food, is within the Fed’s comfort zone for core price increases of between 1 percent and 2 percent.

Core inflation had been above the Fed’s target range through the spring of this year. It peaked at a 2.5 percent increase in February.

Excluding inflation, consumer spending also rose by 0.6 percent in August, the best inflation-adjusted performance since last October. Much of the strength in spending came from a big jump in auto sales, which were driven higher by incentives dealers offered to clear out showrooms in advance of the new model year.

The 0.3 percent rise in incomes was down from a 0.5 percent increase in July and was the slowest performance since no change in April.

Employment fell by 4,000 payroll jobs in August, the first employment drop in four years. Rising employment is the fuel for further spending, so there is that concern if the labor market weakens then consumer spending could falter in coming months.

The overall economy expanded at a solid 3.8 percent rate in the April-June quarter, but analysts believe growth slowed significantly to around 2.5 percent in the current July-September quarter and will slow even further in the final three months of the year.

© 2012 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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