Consumer spending dropped in June for the first time in nearly two years and incomes barely rose, signs the economy lacked momentum as the second quarter drew to a close.

The Commerce Department said on Tuesday consumer spending slipped 0.2 percent, the first decline since September 2009, after edging up 0.1 percent in May. Adjusted for inflation, spending was flat after a 0.1 percent decline.

The growth potential for the economy has slowed significantly, said Yelena Shulyatyeva, a U.S. economist at BNP Paribas in New York.

Stocks on Wall Street opened lower on the data, while Treasury debt prices prices rose. The dollar rose broadly.

The data, which was incorporated in a report on U.S. economic growth on Friday, was the latest to underscore the recovery's frail state.

GDP grew at an anemic 1.3 percent annual rate in the second quarter after edging up at just a 0.4 percent pace in the January to March period. On Monday, a report showed factory activity cooled in June, leading some economists to dial back expectations for growth over the second half of the year.

The recent run of weak economic news has made us more concerned that any rebound will be more modest than previously looked likely, said Paul Dales, senior U.S. economist at Capital Economics in Toronto.

Consumer spending is being held back by a 9.2 percent unemployment rate and the labor market's health could determine how fast the economy recovers from its dismal performance in the first half of the year.

Budget cuts in Washington could hamper the economy's recovery, although most of the fiscal restraint imposed by a plan the Senate will vote on on Tuesday won't take hold for years.

In the second quarter as a whole, inflation-adjusted spending inched up at an annual rate of only 0.1 percent -- the weakest pace since the end of the 2007-09 recession.

The dour data in the last few days have spurred talk that the economy could tumble into a fresh recession.

In an interview with ABC, Treasury Secretary Timothy Geithner said he did not think the economy was facing a very significant recession risk.

Construction is very weak, housing is very weak, and confidence ... has been damaged, he said in an interview with ABC. But if you look at what's happened to exports, if you look at what's happened to investment spending, there's lots of encouraging signs of resilience, too.

In a hopeful sign for the recovery, borrowing by small U.S. businesses jumped in June to the highest level in more than three years.

The Thomson Reuters/Paynet Small Business Lending Index was up 25 percent in June from a year ago, and a separate PayNet survey found small business loan delinquencies fell to the lowest level on records dating to 1995.

INFLATION EASES, HELPS SUPPORT SPENDING

The decline in spending in June came even as gasoline prices retreated from their peak just above $4 a gallon in early May and suggested the much-anticipated bounce back in growth in the third quarter would lack vigor.

The weak spending in June also reflected tepid income growth after employment growth ground to a near halt in June, with nonfarm payrolls rising only 18,000.

Nonfarm payrolls are expected to have increased 85,000 in July, according to a Reuters survey. The government will release its closely followed employment report for July on Friday.

Incomes ticked up 0.1 percent in June, the smallest increase since November, after rising 0.2 percent in May.

Disposable income edged up 0.1 percent, also the smallest increase since November. But when adjusted for inflation, disposable income rose 0.3 percent.

With real disposable income outpacing spending, savings rose to $620.6 billion from $581.7 billion in May.

But there was some silver lining in the generally weak report, which showed overall inflation pressures subsiding as gasoline prices decline a bit.

The personal consumption expenditures price (PCE) index fell 0.2 percent, the first decline since June, after rising 0.2 percent in May. Compared to June last year, the index was up 2.6 percent after increasing 2.6 percent in May.

But the core PCE index -- excluding food and energy - rose 0.1 percent after gaining 0.2 percent the prior month.

The core index, which is closely watched by Federal Reserve officials, increased 1.3 percent in the 12 months through June. The index rose 1.3 percent year-on-year in May and the Fed would like to see it close to 2 percent.

(Additional reporting by Richard Leong in New York and Ann Saphir in Chicago; Editing by Andrea Ricci)

Timothy geithner BNP Paribas Inflation