U.S. consumer spending edged up in July, lifted by the government's cash-for-clunkers program that fueled demand for autos, offering hope a rise in consumption will help fuel an economic recovery.

Incomes, however, were flat after a steep 1.1 percent drop in June, underscoring the pressure on households still faced with falling housing prices and rising unemployment.

The Commerce Department said on Friday spending, which accounts for about two-thirds of U.S. economic activity, rose 0.2 percent after increasing by an upwardly revised 0.6 percent in June.

July's rise was in line with market expectations. Adjusted for inflation, spending was up 0.2 percent after a 0.1 percent gain in June.

Analysts said the data bodes well for a turnaround in consumer spending and supported views the economy would return to growth in the third quarter.

That puts us in pretty good stead for an upturn in consumer spending in the third quarter, said David Resler, chief economist at Nomura Securities International in New York.

We don't expect a big rise, but growth in the neighborhood of 1 percent or so in consumer spending for the third quarter will be an important element of an expected turnaround from decline to growth.

U.S. stock index futures pared gains on the report, while U.S. Treasury debt trimmed losses.

On Thursday, the department said spending fell at a 1 percent annual rate in the second quarter, slightly less than the 1.2 percent decline it had estimated last month. Spending nudged up 0.6 percent in January-March period.

Fears are growing that weak consumer spending, as unemployment stays high and eats into household incomes, will constrain the economy's recovery from the longest and deepest recession in 70 years.

However, labor market distress has subsided in recent months, with the pace of layoffs slowing, though companies are still reluctant to hire new workers.

Personal income was flat in July, the department said. Analysts polled by Reuters had forecast income rising 0.2 percent. Real disposable income edged down 0.1 percent in July. However, private wage and salary disbursements increased $6.7 billion in July after a $24.5 billion drop in June.

The personal income number continues to reflect the anemic job market that we're facing in the U.S. We're still destroying jobs, not creating them, and that's going to pressure personal income for a while, said Craig Hester, chief executive officer at Hester Capital Management in Austin, Texas.

With disposable income declining, savings slipped to an annual rate of $458.5 billion. That took the saving rate to 4.2 percent from 4.5 percent in June, the department said.

Subdued demand is keeping a lid on inflation pressures, the reported showed. A measure of inflation closely watched by the Federal Reserve, the year-on-year personal consumption expenditures price index excluding food and energy, rose 1.4 percent after a 1.5 percent increase in June.

We don't think inflation will be something we'll have to worry about until the economy gains traction. But down the road, because of the amount of money the government has put into the economy, we'll have inflation issues later, said Hester.

(Reporting by Lucia Mutikani; Editing by Neil Stempleman)

Inflation Unemployment