*

Consumer spending drops 0.2% in January

*

PCE price index increases 0.3%; up 2.5% year-on-year

*

Core PCE inflation rises 0.3%; gains 2.6% year-on-year

*

Goods trade deficit jumps 25.6% to record $153.3 billion

By Lucia Mutikani

WASHINGTON, Feb 28 (Reuters) - U.S. consumer spending

unexpectedly fell in January while the annual increase in

inflation slowed, supporting financial market expectations that

the Federal Reserve would resume cutting interest rates in June.

But the moderation in annual inflation, which partly

reflected last year's high readings dropping out of the

calculation, is unlikely to be sustained as President Donald

Trump's administration ratchets up tariffs on imports, which

economists warned would raise prices. Consumers' one-year

inflation expectations soared in February.

"The good news is consumer inflation broke the curse of the

January effect," said Christopher Rupkey, chief economist at

FWDBONDS. "The bad news is consumers are scrambling to process

the winds of change coming out of Washington and have apparently

decided to sit it out and wait."

Consumer spending, which accounts for more than two-thirds

of U.S. economic activity, dropped 0.2% last month after an

upwardly revised 0.8% increase in December, the Commerce

Department's Bureau of Economic Analysis said on Friday.

Economists polled by Reuters had forecast consumer spending

gaining 0.1% after a previously reported 0.7% surge in December,

when outlays were boosted by pre-emptive buying in anticipation

of tariffs. When adjusted for inflation, consumer spending fell

0.5%, the biggest decline since February 2021.

Some of the weakness in consumer spending last month likely

reflected the fading lift from front-running as well as a drag

from unseasonably cold temperatures and snowstorms that engulfed

large parts of the country. Wildfires, which scorched areas of

Los Angeles, also probably hurt spending.

There was also weakness in spending at restaurants and bars,

suggesting that consumers were tightening their purse strings.

Winter storms disrupted homebuilding last month and helped

to curb job growth. The data are consistent with expectations

for a slowdown in economic growth in the first quarter, which

was reinforced by other data on Friday showing the goods trade

deficit surged to a record high last month as businesses

front-loaded imports to avoid duties.

Following the soft consumer spending data and deterioration

in the goods trade deficit, economists are likely to slash their

gross domestic product growth forecasts for the first quarter,

which are currently below a 2.0% annualized rate. The economy

grew at a 2.3% rate in the fourth quarter.

In addition to the weather, economic activity is also seen

hampered by the Trump administration's policies, including sharp

spending cuts, which have so far led to the firing of tens of

thousands of federal government workers and contractors.

Trump in his first month in office has issued a cascade of

tariff orders, imposing an additional 10% levy on goods from

China. On Thursday, Trump said a 25% tariff on Mexican and

Canadian goods will take effect on March 4, after being delayed

for a month, along with an extra 10% duty on Chinese imports.

Other duties aimed at imported steel, aluminum and motor

vehicles will either soon go into effect or are in fast-track

development. Business and consumer confidence have deteriorated

on concerns over tariffs.

PRICES STILL ELEVATED

The Personal Consumption Expenditures (PCE) price index

increased 0.3% in January, matching December's unrevised gain.

The rise was in line with economists' expectations. In the 12

months through January, the PCE price index rose 2.5% after

increasing 2.6% in December.

Stripping out the volatile food and energy components, the

PCE price index gained 0.3% last month after an unrevised 0.2%

rise in December. In the 12 months through January, core prices

increased 2.6% after climbing 2.9% in December.

The Fed tracks the PCE price measures for its 2% inflation

target. Financial markets expect the Fed will resume cutting

rates in June. Stocks on Wall Street opened mixed. The dollar

was little changed against a basket of currencies. U.S. Treasury

yields were lower.

The U.S. central bank paused rate cuts in January, leaving

its benchmark overnight interest rate in the 4.25%-4.50% range,

having reduced it by 100 basis points since September, when it

started its easing cycle.

Minutes of the U.S. central bank's January 28-29 policy

meeting published last week showed policymakers were worried

about higher inflation from Trump's initial policy proposals.

The policy rate was hiked by 5.25 percentage points in 2022 and

2023 to quell inflation.

A separate report from the Commerce Department's Census

Bureau showed the goods trade deficit surged 25.6% to $153.3

billion last month, an all-time high and potentially putting

trade on course to be a drag on GDP this quarter.

Goods imports vaulted 11.9% to $325.4 billion. Export of

goods rose 2.0% to $172.2 billion last month. Trade contributed

to growth last quarter.