Consumer sentiment worsened sharply in early August, falling to the lowest index level since 1980, even though retail sales posted the biggest gains in three months in July, separate reports on Friday showed.

Consumer sentiment dropped to its lowest point in more than three decades as fears of a stalled recovery combined with despair over government policies, a survey showed.

The Thomson Reuters/University of Michigan's preliminary August reading on the overall index on consumer sentiment fell to 54.9, the lowest since May 1980, down from 63.7 in July. It was well below the median forecast of 63.0 among economists polled by Reuters.

High unemployment, stagnant wages and the protracted debate over raising the U.S. government debt ceiling spooked consumers who were polled before the Standard and Poor's downgraded the U.S. government's credit rating on August 5.

Never before in the history of the surveys have so many consumers spontaneously mentioned negative aspects of the government's role, survey director Richard Curtin said in a statement.

This was more than the simple recognition that traditional monetary and fiscal policy measures were largely spent. It was the realization that the government was unable or unwilling to act, Curtin added.

Buying plans for household durables and vehicles declined in early August, falling back to their recession level lows.

Bad times in the economy were expected by 75 percent of all consumers in early August, just below the all-time peak of 82 percent in 1980. Buying plans for household durables and vehicles declined in early August, falling back to their recession level lows.

It counters the really encouraging news that we had with retail sales earlier this morning, said Millan Mulraine, senior U.S. macroeconomics strategist at TD Securities in New York.

While consumers may have hung in July, it may have not been the case in August. It's more consistent with the economy we've been seeing. It's more important nonetheless to gauge where sentiment is. It shows where spending is headed, Mulraine said.

U.S. stocks slipped after the consumer sentiment data after earlier posting gains on the retail sales data. U.S. Treasury yields were little changed after the data.

U.S. RETAIL SALES JUMP IN JULY

However, U.S. retail sales in July posted the biggest gain since March, according to a separate report from the Commerce Department, tempering fears the world's largest economy might be slipping back into recession.

Sales climbed 0.5 percent, in line with analyst forecasts and following an upwardly revised 0.3 percent gain in June, according to Commerce Department data released on Friday.

Consumer spending accounts for two thirds of U.S. economic activity, and the data indicates the third quarter was off to a decent start.

Excluding autos, sales increased 0.5 percent, well above forecasts for a 0.2 percent gain. The figures were bolstered by a 1.6 percent jump in gasoline station sales, in part reflecting the higher cost of fuel.

When you look at the overall data that's been coming out, it's really a mixed bag, and this shows that the economy is not falling off its wheels, said Rudy Narvas, senior economist at Societe Generale in New York.

U.S. economic growth was anemic in the first half of the year and unemployment remained elevated, raising worries that the recovery might again falter and triggering speculation that the Federal Reserve might need to resort to additional monetary easing.

Major U.S. stocks indexes were up at mid-morning, while government debt prices were mostly higher.

Retail sales excluding autos, gasoline and building materials rose 0.4 percent. Sporting goods stores and department stores fared the worst in an otherwise firm report, with sales dropping 1.5 percent and 0.8 percent, respectively.

One month's gain in retail spending was not sufficient to put to rest concerns that the U.S. economy lacks sufficient momentum to create new jobs, particularly with Washington set on cutting spending rather than doing more to stimulate investment and hiring.

Compounding uncertainty, financial markets have been see-sawing this week as investors alternate between seeking opportunity in battered shares prices and fretting that the market could be on the verge of a further dive.

Europe's worsening debt crisis, which has now gone well beyond the so-called periphery and is directly affecting France, has raised the cost of interbank borrowing in money markets, raising the specter of a return to the credit crunch of late 2008.

(Additional reporting by Emily Flitter in New York; Editing by Andrea Ricci)

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