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

Consumer sentiment, which hit its lowest since 1980 when the economy was in recession, fell on fears of a stalled economic recovery combined with gloom from partisan bickering over government debt, the Thomson Reuters/University of Michigan's consumer sentiment survey reported.

The preliminary August reading on the consumer sentiment index fell to 54.9 in early August, down from 63.7 in July, and has fallen for three straight months. The August reading was well below the median forecast of 63.0 among economists polled by Reuters.

However, U.S. retail sales climbed 0.5 percent in July, the biggest jump since March, following a revised rise of 0.3 percent gain in June, according to the U.S. Commerce Department on Friday.

People's spending doesn't always correspond with their mood, said Stephen Stanley, chief economist at Pierpont Securities in Stamford, Connecticut. I doubt things are as weak as the sentiment readings suggest, but no doubt people will be cautious in August.

U.S. stocks were up about 1 percent on Friday afternoon as the mildly encouraging retail sales data put the S&P500 stock index on track for a two-day winning streak for the first time since mid-July after investors shrugged off the weak consumer sentiment data.

Still, the stock market was on track for its worst three-week decline since March 2009, when stocks hit 12-year lows.

The tumultuous last 10 days or so hasn't given our core customer, the middle income family, any reason to be more confident, said JC Penney Chief Executive Myron Ullman on an analysts conference call Friday morning after the retailer forecast weaker-than-expected third-quarter earnings.

J.C. Penney Co Inc on Friday reported second-quarter profit was little changed from a year earlier at $14 million, or 7 cents per share. Net sales were down 0.8 percent to $3.91 billion.

GLOOM ABOUT GOVERNMENT

High unemployment, stagnant wages and the protracted debate in Congress over raising the U.S. government debt ceiling spooked consumers in the University of Michigan survey even before the downgrade of U.S. sovereign debt by Standard & Poor's. The consumer sentiment index registered most of the decline before the credit rating downgrade 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.

Bad economic times 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.

Obviously this is quite an ugly number, said Peter Cardillo, chief market economist at Rockwell Global Capital in New York.

How could you have hopes for anything less than what we got, with the markets being in turmoil, the fear, and the U.S. being downgraded? It took the wind out of the stock market a bit, but I don't think it will be that meaningful.

U.S. RETAIL SALES JUMP IN JULY

However, U.S. retail sales in July posted the biggest gain since March, tempering fears the world's largest economy might be slipping back into recession.

The 0.5 percent increase was in line with analyst forecasts and followed an upwardly revised 0.3 percent gain in June.

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. Retail sales excluding autos, gasoline and building materials rose 0.4 percent.

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 [ID:nN1E77B0I4].

The global financial market volatility of the past week and the state of the U.S. economy will be on the agenda when President Barack Obama meets on Friday with U.S. business leaders, including chief executives from Johnson & Johnson, Wells Fargo & Co, US Bancorp, Xerox Corp, BlackRock Inc and Silver Bridge.

Obama's hopes for re-election in 2012 will likely hinge on his success in lowering unemployment from its current 9.1 percent, boosting sluggish economic growth and restoring confidence lost from the Standard & Poor's downgrade and fractious debt talks.

(Editing by Andrea Ricci and Neil Stempleman)

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