updated 8/3/2004 9:14:32 AM ET 2004-08-03T13:14:32

Hit with higher energy prices, U.S. consumers slashed their spending in June by the largest amount in three years the Commerce Department reported early Tuesday.

Major Market Indices

The government said U.S. consumer spending dropped by a sharp 0.7 percent in June from the previous month. The retrenchment came after consumers splurged in May, ratcheting up spending by a strong 1 percent.

Americans’ incomes rose by 0.2 percent in June, down from a solid 0.6 percent increase the month before. The figures are not adjusted for price changes.

The latest snapshot of consumer spending was weaker than economists were expecting. They were forecasting a tiny 0.1 percent dip in spending and a 0.3 percent rise in incomes for June.

Consumer spending accounts for roughly two-thirds of all economic activity in the United States. Thus it plays a key role in shaping an economic recovery.

Federal Reserve Chairman Alan Greenspan, appearing before Congress last month, acknowledged that the economy had hit a soft spot in June. He said that higher energy prices had sapped consumer spending but he predicted that the softness in spending would be short-lived.

Greenspan expressed confidence that the economy, which grew by a disappointing 3 percent annual rate in the second quarter of this year, would pick up momentum in the coming months. He noted that anecdotal data for July seemed promising.

In June though, the weakness in consumer spending was fairly widespread. The 0.7 percent decline in spending was the first since September 2003 and the largest drop since September 2001.

The decline was led by a cutback in spending on automobiles and other big-ticket durable goods. Spending on durable goods declined by 5.9 percent in June, compared with a 3.7 percent rise in May. For non-durables, such as food and clothes, spending dipped by 0.3 percent, following a 1.4 percent increase. Spending on services rose by 0.2 percent, down from a 0.3 percent increase.

Greenspan and other economists have noted that auto sales after a bad June have improved in July as dealers offer more generous incentives to boost sales.

Wages were flat in June after a 0.6 percent rise in May. That reflected a sluggishness that hit the job market, causing businesses to show more caution in hiring in June.

Tuesday’s report is consistent with a string of other economic data in June — including the employment report, retail sales and industrial production — that suggested the economy took a bit of a breather during that month.

Even so, economists are still expecting the Federal Reserve to boost short-term interest rates again when it meets next on Aug. 10. The Fed raised interest rates on June 30 for the first time in four years. It raised a key rate to 1.25 percent, from a 46-year low of 1 percent at that time.

Economists believe the Fed will raise rates next week by another 1/4 percentage point in a bid to keep inflation from becoming a problem.

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