Worries over high unemployment pushed U.S. consumer confidence to a four-month low in August, while spending rose modestly in July, indicating the economy's recovery from recession would be lethargic.

The Reuters/University of Michigan Surveys of Consumers said on Friday its final index of confidence for August fell to 65.7, the lowest since April, from 66.0 in July. However, sentiment improved from early this month.

A separate report from the Commerce Department showed consumer spending edged up 0.2 percent in July, largely driven by the government's cash-for-clunkers program that fueled demand for autos, after increasing 0.6 percent in June.

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

The big driver of the economy is still on the sidelines. The household sector is worried about the job market and until that shows some significant improvement, households are going to be pretty restrained, said Bill Hampel, chief economist at the Credit Union National Association in Washington.

The weak consumer sentiment report cast more doubt on the economy's recovery from the worst slump in 70 years, hurting stocks and helping bonds. The Dow Jones industrial average index fell 36.43 points to 9,544.20. The benchmark 10-year Treasury note was up 3/32, yielding 3.44 percent.

U.S. government bonds are considered a safe-haven in the financial markets.

While data ranging from home sales to factory activity have been fairly upbeat, indications are that consumers will play a limited role in the recovery, widely believed to be under way.

The economy's recovery was seen driven by the rebuilding of inventories after a record aggressive drawdown by companies and increased government spending.

Consumer spending, which accounts for about two-thirds of U.S. economic activity, fell at a 1 percent annual rate in the second quarter after a 0.6 percent gain in the prior period.

RECOVERY EYED

Still, analysts were encouraged by the gain in July spending and upward revisions to June's figures.

That raised hopes consumption would recover in the third quarter as an improvement in the economic outlook and slowdown in the pace of layoffs boost consumer sentiment and encourage households to spend more, they said.

Consumer morale was starting to perk up in late August, according to the Reuters/University of Michigan survey. The cash-for-clunkers incentives that supported spending in July were expected to boost August's numbers as well.

We don't expect a big rise, but growth in the neighborhood of 1 percent or so in consumer spending (in the third quarter) will be an important element of an expected turnaround from decline to growth, said David Resler, chief economist at Nomura Securities International in New York.

Personal income was flat in July, where analysts polled by Reuters had forecast a rise of 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, the first gain since last August, after a $24.5 billion drop in June. The increase probably reflected the slowdown in layoffs during the month.

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 down to 4.2 percent from 4.5 percent in June, the department said.

Subdued demand is keeping a lid on inflation pressures, the report 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 -- the lowest since October 2003 -- after a 1.5 percent rise 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, said Hester.

(Additional reporting by Burton Frierson and Chris Reese in New York; Editing by Kenneth Barry)

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