Consumer spending was unexpectedly flat in April after six straight months of gains, but growing consumer confidence in the economic outlook suggested consumption will remain strong this quarter.

Although spending was unchanged, real disposable income recorded its biggest gain in nearly a year, Commerce Department data showed on Friday, boosted by a combination of an improving labor market and tame inflation.

Markets had expected consumer spending, which normally accounts for over two-thirds of U.S. economic activity, to increase 0.3 percent after a 0.6 percent rise in March.

Separately, the Thomson Reuters/University of Michigan's index of consumer confidence edged up to 73.6 this month from 72.2 in April. Even more encouraging, measures of consumers' expectations and outlook of the economy over a 12-month horizon were the highest since January.

Confidence rose despite the stock market distress triggered by the fiscal crisis in Europe.

Consumers are clearly untroubled by the turmoil in the stock market. They haven't seen anything yet but they might if the European crisis materializes in slower job growth, said Chris Low, chief economist at FTN Financial in New York.

U.S. stock indexes trimmed losses on the data, while Treasury debt prices slipped. The U.S. dollar weakened marginally.

Another report showed business activity in the country's Midwest grew less than expected in May after scaling a five-year high the prior month. An employment gauge in the Institute for Supply Management-Chicago's survey slipped.

SPENDING SEEN UP

Despite April's flat reading, analysts expect strong spending in the second quarter as a firming labor market boosts household incomes and tame inflation bolsters spending power.

I think the consumer is going down the right path of recovery. As the labor market heals, consumer spending should remain strong, said Sean Simko, fixed-income portfolio manager at SEI in Oaks, Pennsylvania.

Government data on Thursday showed real consumer spending rose at a 3.5 percent annual rate in the first quarter, more than double the 1.6 percent pace in the October-December period.

Economic recovery is a key goal for President Barack Obama as tough tests loom in November's congressional elections. Voters are in an anti-incumbent and anti-Washington mood over the recent recession, Wall Street's role in the crisis, job losses and the weak housing market.

Spending adjusted for inflation was also flat in April after a 0.5 percent increase the prior month, the Commerce Department said.

Personal income rose 0.4 percent, the report showed, after rising by the same margin in March. Markets had expected income to rise 0.5 percent last month.

Real disposable income rose 0.5 percent in April, the largest increase since May 2009, after a 0.3 percent gain the prior month. The saving rate rose to 3.6 percent from 3.1 percent in March.

The report also showed the personal consumption expenditures price index, excluding food and energy, rising 1.2 percent in the 12 months to April, the smallest rise since September. The index, a key inflation gauge monitored by the Federal Reserve, increased 1.3 percent in March.

The combination of tame inflation and excess capacity in the economy, even as the recovery gains traction, means more room for the U.S. central bank to hold benchmark interest rates ultra low for an extended period.

Separately, business activity in New York City grew at a record pace in May, marking the fifth largest gain on record.

The Institute for Supply Management-New York's seasonally adjusted index of current business conditions showed the May level was the highest since the survey began in 1993. In May, the index rose to 89.9 from 62.2 in April. The 50 level separates growth from contraction.

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graphic of U.S. price indexes and inflation expectations:

http://r.reuters.com/quf96k

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(Reporting by Lucia Mutikani; Additional reporting by Ann Sphir, Caroline Valetkevitch and John Parry in New York; Editing by Neil Stempleman)

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