U.S. consumer spending rose in March as households stretched to cover higher costs for food and gasoline, with inflation posting its biggest year-on-year rise in 10 months.

Despite the rising cost of living, consumers grew a bit optimistic about the economy this month and even dialed down their expectations for inflation over the next five to 10 years, another report showed on Friday.

Consumer spending rose 0.6 percent for a ninth straight month of gains, after advancing 0.9 percent in February, the Commerce Department said.

But prices rose a stiff 0.4 percent leaving the spending that drives 70 percent of the economy up just 0.2 percent after adjusting for inflation.

The story in the first quarter was higher gas prices are forcing people to spend more at the expense of other items, said Christopher Low, chief economist at FTN Financial in New York. The inflation burden increased in the quarter, things were progressively worse as you moved from January to March.

The Thomson Reuters/University of Michigan's consumer sentiment index rose to 69.8 from 67.5 in March. The survey's one-year inflation expectation was unchanged at 4.6 percent, but the five-to-10-year inflation outlook slipped to 2.9 percent from 3.2 percent in March.

A third report showed factory activity in the country's Midwest slowed this month, potentially indicating some cooling in manufacturing. The Institute for Supply Management-Chicago business barometer dropped to 67.6 in April from 70.6 in March. Economists had forecast an April reading of 68.5.

The mixed economic reports had little impact on U.S. financial markets, where strong quarterly earnings from Caterpillar Inc lifted stocks on Wall Street. Prices for U.S. government debt were little changed, while the dollar hovered near a three-year low against a basket of currencies.

CONSUMERS RESILIENT

The government said on Thursday that consumer spending growth slowed to a 2.7 percent annual rate in the first quarter after a 4 percent rise in the final three months of 2010.

That gain, which took into account the spending data released on Friday, was a factor behind a slowing in overall economic growth to a 1.8 percent pace at the start of this year from the 3.1 percent expansion in the last quarter of 2010.

The moderation in spending was not as sharp as economists had feared, showing consumers remained surprisingly resilient in the face of higher prices for food and fuel.

Consumers could be put to the test, however, if gasoline prices shoot above $4 a gallon. The national price for regular unleaded gasoline rose 3.5 cents to $3.88 in the week through Monday.

Federal Reserve Chairman Ben Bernanke on Wednesday expressed confidence high energy prices would not spark broader inflation, saying gasoline costs should stabilize.

Consumer prices rose 0.4 percent in March for a second straight month, according to an inflation gauge in the spending report. Over the past year, price have risen 1.8 percent -- the largest increase since May and an acceleration from the 1.6 percent logged in the 12 months through February.

The core PCE index -- excluding food and energy - slowed to a 0.1 percent increase after rising 0.2 percent in February. Core prices have risen just 0.9 percent over the past 12 months, just a touch above the all-time low of 0.7 percent struck in December.

Fed officials watch the core measure closely to gauge underlying price trends.

Incomes increased 0.5 percent last month after a 0.4 percent gain in February, but wages an salaries only advanced 0.3 percent. Subdued wage growth is helping to keep a lid on prices.

A separate report from the Labor Department showed wages grew at a tepid 0.4 percent rate in the first quarter, and were up only 1.6 percent from a year ago.

(Reporting by Lucia Mutikani; Additional reporting by Karen Brettell in New York; Editing by Andrea Ricci)

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