Consumer spending rose at the strongest pace in four months in July, supported by a small gain in incomes that offered hope consumers will be able to keep contributing to a modest economic recovery.

Analysts said the 0.4 percent increase in spending reported by the Commerce Department on Monday was a relief after a raft of weak data for July and helped ease fears the economy was sliding back into recession.

We are still of the opinion that there is a 30 percent chance of a double dip (recession), but it's definitely not our baseline forecast, said Scott Hoyt, director of consumer economics at Moody's Economy.com in West Chester, Pennsylvania. When consumer spending is growing it's hard to get a double dip.

The increase in spending was a touch above expectations in financial markets for a 0.3 percent rise. Spending, which was flat in June, was supported by a 0.2 percent gain in incomes and households' dipping into their savings.

But investors worried that stubbornly high unemployment would continue to dampen spending and sold U.S. stocks. Prices for safe-haven government bonds rose, recouping some of Friday's steep losses.

The U.S. dollar fell against the yen as investors saw as inadequate steps by authorities in Tokyo to curb the Japanese currency's rise.

Data so far have suggested the U.S. economy's recovery from the longest and deepest recession since the 1930s probably slowed further in the third quarter.

The government on Friday lowered its estimate of second-quarter economic growth to a 1.6 percent annual rate from 2.4 percent, although the figure on consumer spending was revised higher.

A closely watched employment report for August due on Friday is expected to paint yet another a grim picture of the labor market, the Achilles heel of the recovery. According to a Reuters survey, nonfarm payrolls fell 100,000 this month after shrinking 131,000 in July.

JOBS KEY

The deluge of weak data led Federal Reserve Chairman Ben Bernanke to reiterate on Friday the U.S. central bank's commitment to spur the recovery should the outlook deteriorate.

The sickly economy is damaging President Barack Obama's popularity among Americans unhappy with a 9.5 percent jobless rate. It could see the Democractic Party lose control of Congress to the Republicans in November's mid-term election.

Obama on Monday said he and his economic team had discussed additional steps to promote economic growth, including looking at tax cuts for businesses and the middle class. He implored lawmakers to pass a stalled bill to help small businesses.

I ask senate Republicans to drop the blockade. I know we are entering election season, but the people who sent us here expect us to work together to get things done and improve this economy, Obama said at the White House.

Republicans argue the Democrats' policies have failed to fix the economy and the focus should be on cutting public spending. Job creation is critical for the recovery as consumer spending accounts for 70 percent of economic activity.

Last month, consumer spending adjusted for inflation increased 0.2 percent month after edging up 0.1 percent in June, the Commerce Department said. Real spending on goods rebounded 0.4 percent, while expenditure on services increased 0.2 percent.

Wages and salaries rose at a $22 billion annual rate last month, helping fuel the rise in incomes, after shrinking at an $8 billion rate in June. But real disposable income fell 0.1 percent, the first decline since January.

Although the saving rate slipped to 5.9 percent from 6.2 percent the previous month, analysts said the level still indicated that consumers remained wary of spending.

Households are intent on paying down debt and putting their finances on a firmer footing, said Paul Dales, a U.S. economist at Capital Economics in Toronto.

This is good for the economy in the medium-term, but it's bad for near-term growth. Overall, the U.S. economy cannot rely on households to lift it out of its current funk.

The report showed the personal consumption expenditures price index, excluding food and energy, was up 1.4 percent in the 12 months to July, unchanged from June. The index is a key inflation measure monitored by the Fed.

The sluggish economy and high unemployment should nudge it modestly lower in coming months, said Sal Guatieri, a senior economist with BMO Capital Markets in Toronto. We see it moving further below the Fed's longer-range forecast of 1.7 percent to 2.0 percent, thus paving the way for renewed quantitative easing by year-end.

(Editing by Andrea Ricci and Andrew Hay)

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