U.S. 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 labour 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 key is jobs. If we get jobs, we will get consumers spending, that will really get the ball rolling, said Hoyt.

Spending adjusted for inflation increased 0.2 percent last 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.

Consumers are spending, but slowly, and we expect spending growth below 2 percent in the third quarter as a whole, said Julia Coronado, an economist at BNP Paribas in New York.

Wages and salaries rose at a $22 billion (14 billion pounds) 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.

The saving rate remains high by the standards of the last 20 years, suggesting that 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 clearly 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 Federal Reserve.

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.

Fed Chairman Ben Bernanke said on Friday that the U.S. central bank's would act to spur the recovery should the outlook deteriorate. He said the Fed could support growth by purchasing more government debt or by promising to keep rates exceptionally low for a longer period than currently priced in by financial markets.

(Editing by Andrea Ricci)

Ben Bernanke BNP Paribas