WASHINGTON - Consumers kept spending in August and factories kept producing, but the gains were weaker than expected as financial market turbulence and a slumping housing market continued to weigh on the economy.
Analysts said the new economic reports released Friday give the Federal Reserve more reasons to cut a key interest rate when policymakers meet next week.
The Commerce Department said retail sales increased 0.3 percent in August with the strength led by a 2.8 percent jump in auto sales, the biggest increase in this category in more than a year.
Separately, the Federal Reserve said industrial output edged up by 0.2 percent in August with all of the strength coming from a big jump in utility production in response to an August heat wave. Manufacturing dropped for the first time since February.
Analysts said the lackluster showing for sales and production added pressure on the Fed to start cutting interest rates to make sure the financial market turmoil of the past month does not push the country into a recession.
'Consumers have turned more cautious under the weight of the weakening housing market, high gasoline prices and now a fragile job market,' said Mark Zandi, chief economist at Moody's Economy.com. 'The retail sales number is just one more reason for the Fed to lower rates.'
On Wall Street, the Dow Jones industrial average rose 17.64 points Friday to close at 13,422.52, giving the blue chip index a 2.5 percent gain for the week, its best showing since April.
Consumer confidence, as measured by the RBC Cash Index, fell to 71.1 in early September, the worst showing since May 2006. A University of Michigan preliminary reading for September moved to 83.8 from 83.4 at the end of August, but that followed a sharp drop from the July level.
The worry is that consumer spending, which accounts for two-thirds of total economic activity, could falter in coming months, dragging the country into a full-blown recession. The government reported last week that businesses cut 4,000 jobs in August, the first job losses in four years.
Many economists predicted the Fed would cut its target for the federal funds rate, the interest that banks charge each other, by a quarter-point to 5 percent. It would mark the first reduction in four years in the funds rate, which directly influences banks' prime lending rate, the benchmark for millions of consumer and business loans.
Some analysts said a half-point cut in the funds rate could be justified, given all the bad economic news recently, but the Fed under Chairman Ben Bernanke is likely to want to proceed more cautiously.
Lyle Gramley, a former Fed governor who is now an economist with Stanford Financial Group, said he believed unfolding weakness coming from the worst slump in housing in 16 years would eventually force the Fed into more aggressive rate cuts. He predicted a quarter-point cut in September would be followed by a half-point reduction in October.
Gramley said the slump in housing sales and construction would become more severe in coming months as mortgage defaults dump more homes onto an already glutted market and potential buyers find it more difficult to qualify for loans because of tighter lending standards.
'You get as big a decline in housing as we are looking at and that is serious business,' Gramley said, who put the odds of a recession at close to 50-50.
Treasury Secretary Henry Paulson said Friday he believed the economy could avert a downturn, in part because the rest of the world is growing at a robust pace, helping to boost U.S. exports. Another government report showed the deficit in the current account, the broadest measure of trade, shrank in the April-June quarter to $190.8 billion, down 3.1 percent from the first quarter.
Financial markets have been roiled since early August by rising worries that loans to consumers and businesses are becoming harder to obtain as banks and other lenders tighten standards. The credit crunch began with rising defaults on subprime mortgages, home loans provided to borrowers with weak credit. But those problems have since spread to other lending areas and have also roiled global financial markets.
Paulson said there has been 'some modest improvement in a number of markets that are under stress' but that the current credit crisis will take some time to unwind.
'The complexity of certain of the products and the fact that we are more integrated into the global economy mean that it is going to take awhile to work our way through this,' Paulson said in an interview on CNBC. 'I feel very confident this economy is going to continue to grow.'
The retail sales performance would have been much weaker without the big auto sales gain in August. Excluding autos, retail sales would have fallen by 0.4 percent, the poorest showing in nearly a year.
Part of the weakness in August retail sales came from a 2.4 percent drop in revenues at gasoline stations, reflecting declining prices. However, with oil rising to new records above $80 per barrel, analysts predicted that gasoline prices will start rising again, a factor that will mean consumers will have less to spend on other items.
Sales at department and general merchandise stores edged up 0.3 percent in August, reflecting strong back-to-school sales. Sales at furniture stores were up 0.5 percent but hardware stores saw sales decline by 1 percent. Sales at specialty clothing stores dropped by 0.1 percent.