July 10 (Bloomberg) -- Sentiment among U.S. consumers, whose spending is critical to an economic recovery, dropped in July after four months of gains as unemployment approached 10 percent.

The Reuters/University of Michigan preliminary index of consumer sentiment fell by more than forecast to 64.6 from 70.8 in the prior month. A separate report from the Commerce Department showed the trade deficit unexpectedly narrowed in May to the lowest level in almost a decade.

Unemployment is rising even as economists predict an end to the recession in coming months. Consumers in the survey said they are less likely to buy cars or appliances, suggesting that the recovery may be weaker than anticipated.

“There’s a lot of concern about job losses, and people think they won’t be able to earn more,” said Jonathan Basile, an economist at Credit Suisse Holdings Inc. in New York. “Until the employment picture clears up, we can’t anticipate persistent gains in consumer spending.”

The confidence index was forecast to dip to 70, according to the median of 59 economists surveyed by Bloomberg News. A gauge of expectations for six months from now, which more closely projects the direction of consumer spending, plunged to 60.9, the biggest drop since October, from 69.2.

The report helped send stocks lower, with the Standard & Poor’s 500 Index falling 0.4 percent to 879.13 for its fourth straight weekly loss. The Dow Jones Industrial Average declined 0.5 percent to 8146.52

Trade Deficit

The trade deficit narrowed 9.8 percent to $26 billion, the smallest gap since November 1999, from a revised $28.8 billion in April, today’s Commerce Department report showed. The gap was projected to widen to $30 billion, from an initially reported $29.2 billion in April, according to the median forecast in a Bloomberg News survey of 71 economists.

A shrinking deficit signals trade will add more to U.S. gross domestic product as exports to emerging economies such as Brazil increase. U.S. demand for imported auto parts was held down by production cutbacks and factory shutdowns by Detroit- based General Motors Corp. and Chrysler LLC, based in Auburn Hills, Michigan, two of the three largest U.S. automakers.

“Demand in the rest of the world is stabilizing sooner than in the U.S.,” Basile said. “If it continues like this, trade could wind up adding to growth.”

A Labor Department report today showed prices of goods imported into the U.S. rose 3.2 percent in June, the fourth monthly gain, as oil costs jumped by the most in a decade.

Inflation Outlook

Consumers in the University of Michigan survey said they expect an inflation rate of 3 percent over the next 12 months, compared with 3.1 percent in the prior month’s survey. Over the next five years, the figures tracked by Federal Reserve policy makers, Americans expected a 3.1 percent rate of inflation, compared with their 3 percent forecast last month.

An index of current conditions, which reflects Americans’ perceptions of their financial situation and whether it is a good time to buy big-ticket items like cars, fell to 70.4 from 73.2.

Employers reduced payrolls by 467,000 last month, more than anticipated, government figures showed last week. Economists surveyed by Bloomberg this month predicted the unemployment rate will surge to 10 percent by the end of the year, from 9.5 percent in June.

The same survey said the economy will expand faster than previously forecast in the second half of this year and in 2010. Growth will average 1.5 percent in the July-to-December period, compared with last month’s 1.2 percent projection, according to the median of 57 forecasts taken from July 2 to July 8.

Retail Sales

Sales reports at retailers reflect caution among consumers, who are shifting purchases to discount stores.

June sales at stores open at least a year rose at Ross Stores Inc., the Pleasanton, California-based owner of the Ross Dress for Less discount chain, and Framingham, Massachusetts- based TJX Cos., owner of T.J. Maxx stores.

Same-store sales fell more than forecast for clothing retailers Abercrombie & Fitch Co., based in New Albany, Ohio, and Gap Inc., based in San Francisco.

The preliminary Reuters/University of Michigan consumer confidence report reflects about 300 responses, compared with 500 households for the final survey.

To contact the reporter on this story: Shobhana Chandra in Washington at schandra1@bloomberg.net

Last Updated: July 10, 2009 17:01 EDT