By Shobhana Chandra
Feb. 29 (Bloomberg) -- Inflation eroded gains in U.S. consumer spending and a gauge of business sentiment fell to the lowest level in more than six years, pushing the economy toward a recession.
While purchases rose 0.4 percent in January, the Federal Reserve's preferred measure of inflation climbed 0.3 percent, the most in four months, the Commerce Department said today in Washington. The National Association of Purchasing Management- Chicago said its index of business activity tumbled to 44.5 in February. Readings below 50 signal a contraction.
The reports pushed Treasury notes higher and stocks down. Confidence among consumers is waning as fuel costs jump and house values slide, leaving exports to drive factory production.
``There is no growth in consumption except to keep up with price increases,'' said Chris Low, chief economist at FTN Financial in New York. ``Consumers are clearly hard-pressed to maintain their standard of living and are cutting back.''
Traders increasingly anticipate the Fed will reduce its benchmark interest rate by 0.75 percentage point at or before the March 18 meeting of policy makers, according to futures prices. The chance of a three-quarter-point cut rose to 56 percent from 36 percent yesterday and 2 percent a week ago.
Treasury notes extended their advance, pushing the yield on the benchmark 10-year note down 9 basis points to 3.57 percent at 11:11 a.m. in New York. A basis point is 0.01 percentage point. The Dow Jones Industrial Average weakened 1.7 percent to 12,369. The dollar remained lower against the yen.
``The big issue is the fact that inflation is accelerating and it's taxing consumer spending,'' said Drew Matus, a senior economist at Lehman Brothers Holdings Inc. in New York. ``The first half is not going to look all that good.''
The Reuters/University of Michigan final index of consumer confidence decreased to 70.8, from 78.4 in January. The measure is the lowest final reading since February 1992 and compares with a preliminary level of 69.6 reported two weeks ago.
Incomes rose 0.3 percent after a 0.5 percent gain the prior month, today's spending report showed. The median forecast was a gain of 0.2 percent.
The report's measure of overall prices rose 0.4 percent and was up a more-than-expected 3.7 percent in the year ended January, the most since September 2005.
The inflation gauge tracked by the Fed, which excludes food and fuel costs, rose 2.2 percent from January 2007.
``In real terms, we are still aiming for nearly flat real consumption for the quarter,'' Mickey Levy, chief economist at Bank of America Corp. in New York, said in a Bloomberg Television interview.
Economists forecast spending would rise 0.2 percent, after an originally reported 0.2 percent increase in December, according to the median of estimates in a Bloomberg News survey.
The savings rate dropped 0.1 percent for a second month. A negative rate suggests consumers are drawing down savings to maintain spending.
Inflation-adjusted spending on durable goods, such as autos, furniture, and other long-lasting items, dropped 1.3 percent. Purchases of non-durable goods decreased 0.2 percent and spending on services, which account for almost 60 percent of all outlays, increased 0.4 percent.
The economy lost jobs in January for the first time in more than four years, and economists surveyed by Bloomberg this month forecast the unemployment rate will rise through midyear.
Warning From Toll
Toll Brothers Inc., the largest U.S. luxury homebuilder, this week reported its biggest quarterly loss in 22 years as the worst housing recession in more than two decades forced the company to write down the value of developments.
``Ceaseless talk of a recession continues to dampen the mood of consumers,'' Chief Executive Officer Robert Toll said on a Feb. 27 conference call. ``This drumbeat, coupled with concerns over mortgages, the direction of home prices, and foreclosures, has kept pent-up demand on the sidelines.''
For now, policy makers have signaled they are more concerned about the economic growth outlook than the acceleration in inflation.
``Downside risks to growth remain,'' Bernanke said in semiannual testimony to Congress this week. The Fed ``will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks.''
The Congress and the administration have also passed a $168 billion stimulus package to try to revive growth. Still, a Bloomberg/Los Angeles Times survey from Feb. 21 to Feb. 25 showed most Americans plan to save rather than spend the plan's tax rebates, indicating it may give less of a boost than intended.