By Lucia Mutikani
Consumer spending increased 0.6 percent, the Commerce Department said on Friday, after a 0.2 percent gain in August. However, incomes edged up only 0.1 percent after a 0.1 percent August drop.
The solid increase in consumer spending -- which accounts for about 70 percent of U.S. economic activity -- lends momentum to fourth-quarter output, but the economy could flag if income growth does not pick up.
"Consumers are really walking a tight rope here. They don't have much room and it's easy for them to lose balance with very modest shifts in hiring, the cost of food and everything," said Steve Blitz, senior economist, ITG Investment Research in New York.
JPMorgan raised its forecast for fourth-quarter growth to a 2.5 percent annual rate from 1 percent to take into account a stronger run of recent data, including the figures on spending, and rebound in stock markets.
Still, with household budgets stretched, analysts warned the current pace of expansion could prove fleeting if job growth does not accelerate.
The report showed saving slowed to an annual rate of $419.8 billion, the lowest level since August 2009, from $479.1 billion in August.
After accounting for taxes and inflation, income slipped 0.1 percent, a third straight monthly drop. For the third quarter as a whole, it fell at an annual rate of 1.7 percent -- the first quarterly decline since the fourth quarter of 2009.
The weak income growth reflects the anemic labor market, characterized by a jobless rate that has been stuck above 9 percent for five consecutive months.
Economists are cautiously optimistic a recent rally in stock markets as Europe tackles its debt crisis will help to shore up consumer confidence, which has dropped to recession levels, and encourage businesses to step-up hiring.
Consumer moods brightened slightly in October, with the Thomson Reuters/University of Michigan's sentiment index rising to 60.9 from 59.4 in September.
"We expect income growth will rebound in the fourth quarter as employment strengthens, which would support continued gains in spending and a gradual recovery in the savings rate," said John Ryding, chief economist at RDQ Economics in New York.
The saving rate, the percentage of disposable income socked away, fell to 3.6 percent, the slowest since December 2007, from 4.1 percent in August.
Stocks on Wall Street were marginally lower after a big rally on Thursday, while prices for U.S. Treasury debt and the U.S. dollar rose.
A separate report underscored the troubling signals on income. The Labor Department said wages and salaries rose 0.3 percent in the third quarter -- the smallest gain in a year -- after increase 0.4 percent in the prior quarter.
The report showed benefit costs borne by employers, which make up about 30 percent of overall compensation, grew just 0.1 percent in the quarter, the weakest since the first quarter of 1999.
Some companies, like Wells Fargo, which are looking to cut costs, are rolling out insurance plans with employees paying higher premiums if they get sick.
Weak incomes are likely to draw the attention of policymakers at the Federal Reserve when they meet next week to debate additional ways to aid growth and cut the jobless rate.
Officials who want to take further action to aid the economy may be emboldened by a slowing in inflation shown by the report on spending, although slower inflation also eases the burden on consumers.
A price index for personal spending rose at a 0.2 percent rate last month, slowing from August's 0.3 percent pace. In the 12 months through September, the PCE index was up 2.9 percent, the same margin as in August.
A core inflation measure, which strips out food and energy costs, was flat last month after increasing 0.2 percent in August. In the 12 months through September, this gauge rose 1.6 percent after increasing 1.7 percent in August.
The Fed would like this measure to be closer to 2 percent.
(Additional reporting by Jason Lange; Editing by Neil Stempleman)