Jan. 31 (Bloomberg) -- Consumer spending in the U.S. increased at the slowest pace in six months and filings for unemployment insurance jumped, spurring bets that the Federal Reserve will need to keep reducing interest rates.

Purchases rose 0.2 percent in December after a 1 percent gain the month before, the Commerce Department said today in Washington. The Labor Department said jobless claims rose to a 27-month high last week, though the figures may have been distorted by adjusting for holidays, a spokesman said.

Treasuries advanced, stocks slid and odds that the Fed will cut rates another half-point to 2.5 percent by March rose to 68 percent, futures showed. Consumers, who have helped the economy weather the worst housing recession in a quarter-century, may further rein in spending after declines in home and stock values, gains in fuel costs and reduced access to credit, economists said.

``With job growth slowing and gasoline prices remaining very high, consumer spending is likely to post very meager gains over the next couple of months,'' said Mark Vitner, a senior economist at Wachovia Corp. in Charlotte, North Carolina. The argument that the Fed is being too aggressive in lowering rates ``is now off the table,'' he said.

A measure of U.S. business activity fell this month from a six-month high as new orders and employment slowed, a private report also showed today. The National Association of Purchasing Management-Chicago's business barometer fell to 51.5 from 56.4 a month earlier. Figures greater than 50 signal growth.

Stocks Drop

Yields on benchmark 10-year Treasuries fell to 3.63 percent at 11:46 a.m. in New York, from 3.67 percent late yesterday. The Standard & Poor's 500 stock index was up 0.5 percent to 1,362.4.

Economists had forecast a 0.1 percent increase in spending, after an originally reported 1.1 percent gain in November, according to the median of 73 estimates in a Bloomberg News survey.

``Consumers are becoming more cautious,'' said Nigel Gault, chief U.S. economist at Global Insight Inc. in Lexington, Massachusetts, who accurately forecast the spending gain. ``We expect the Fed to continue to cut interest rates as it battles recession risks.''

The Commerce report also showed that incomes rose 0.5 percent after a 0.4 percent gain the prior month. Incomes were projected to rise 0.4 percent, the same as in November, according to the survey median.

Inflation Rate

The Fed's preferred measure of inflation rose 0.2 percent for a third straight month. It increased 2.2 percent from December 2006, the same as in November.

Fed policy makers yesterday lowered the benchmark interest rate by half a point, eight days after an emergency three- quarter point reduction, the fastest easing in monetary policy since 1990. ``Downside risks to growth remain,'' and the central bank will ``act in a timely manner as needed,'' officials said.

Initial applications for unemployment insurance rose 69,000 to 375,000, in a week when data may have been distorted by adjusting for the Jan. 21 holiday, a Labor spokesman said. The number of people staying on benefit rolls rose to 2.716 million in the week ended Jan. 19, from 2.669 million in the prior week.

``These are levels that are indicative of a recession,'' James Caron, global head of interest-rate strategy at Morgan Stanley in New York, said in a Bloomberg Television interview. ``If the trend continues to be high jobless-claims numbers like this, it's going to really add some validity to the expectations that the U.S. is, in fact, in a recession at this time.''

January Jobs Data

The Labor Department's January employment report will be released tomorrow. Economists forecast the jobless rate held at 5 percent for a second month, the highest in two years. Employers probably hired 70,000 workers after adding 18,000 in December, according to the Bloomberg survey.

Monster Worldwide Inc., the New York-based owner of the most-used Internet site for help-wanted advertising, said today its employment index declined in January to the lowest level in almost two years.

Newspaper publisher New York Times Co. today reported a fourth-quarter profit that was lower than analysts' estimates after advertising sales plunged 12 percent in December from a year earlier.

The increase in claims was the biggest since just after Hurricane Katrina in September 2005. The four-week moving average, a less volatile measure than initial claims, rose to 325,750 from 315,500 the prior week.

Labor Expenses

A separate report from Labor showed employment costs rose 0.8 percent in the fourth quarter of 2007, the same as in the prior three months.

Adjusted for inflation, spending stalled in December, after a 0.4 percent gain the prior month, the Commerce Department said. For all of 2007, consumer spending rose 5.5 percent, the smallest gain in four years.

Because the increase in spending was smaller than the gain in incomes, the savings rate rose to 0.2 percent, from zero. A positive rate suggests consumers are rebuilding savings.

The economy expanded at an annual rate of 0.6 percent from October to December, down from 4.9 percent in the prior three months, Commerce reported yesterday. The pace was half that forecast by economists.

Consumers may be starting to succumb to mounting headwinds. Retailers' holiday sales rose 2.2 percent, the smallest gain in five years, according to the International Council of Shopping Centers. American Express Co., the third-largest U.S. credit- card network, this week said fourth-quarter profit fell 9.9 percent after setting aside more for customer defaults.

`Very Challenging'

The economy may ``continue to be very challenging,'' Jim Ziemer, chief executive officer of Harley-Davidson Inc., the biggest U.S. motorcycle maker, said in an interview last week. The Milwaukee-based company's fourth-quarter profit and sales both tumbled.

Businesses offering bargains may fare better. Royal Caribbean Cruises Ltd., the world's second-largest cruise-ship operator, this week said fourth-quarter profit rose 52 percent as travelers looking for low-priced vacations booked more trips.

Conditions in the labor market will determine whether spending ultimately falters, economists said.

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

Last Updated: January 31, 2008 11:54 EST