Aug. 18 (Bloomberg) -- Confidence among U.S. consumers fell in August to the lowest level since October as Americans paid higher prices at the gasoline pump.

The University of Michigan's preliminary index of consumer sentiment declined more than forecast, to 78.7 from 84.7 in July. Spending by consumers accounts for about three-fourths of gross domestic product.

The conflict in Lebanon, which drove energy prices higher, and news of a foiled plot to blow up airliners in London probably contributed to the decline in confidence, economists said. The report adds to signs of an economic slowdown that prompted the Federal Reserve to suspend its two-year campaign of interest-rate increases last week.

``Consumers are a bit edgy,'' said Haseeb Ahmed, an economist at JPMorgan Chase & Co. in New York. ``To the extent that it shows a downside to the consumer, it is in line with Fed expectations of slowing growth.''

The Michigan index was expected to decline to 83.8 in August, according to the median estimate of 53 economists in a Bloomberg News survey. Forecasts ranged from 80 to 86. The measure has averaged 88.1 since monthly data were first compiled in 1978.

The expectations index, which some economists view as an indicator of future consumer spending, declined to 64.5 from a July reading of 72.5.

A gauge of current conditions, which reflects Americans' perceptions of their financial situation and whether it's a good time to buy big-ticket items like cars, dropped to 100.8 from 103.5.

Inflation Expectations

Consumers in the Michigan survey said they expect an inflation rate of 4.2 percent in one year, up from 3.2 percent in the July survey and the highest since October 2005.

The preliminary Michigan sentiment index is based on a telephone survey of about 300 households. The final report for the month, due Sept. 1, will reflect about 500 responses.

The Fed kept interest rates unchanged at 5.25 percent last week after 17 straight increases, saying that economic growth has slowed and inflation pressure is likely to ease.

``The U.S. economy is slowing from its unsustainable, blistering pace of earlier this year,'' Federal Reserve Bank of Dallas President Richard Fisher said Aug. 16 in remarks at a real estate conference in Dallas.

``The housing downturn and the cumulative effect of energy and electricity price increases and higher interest rates, among other factors, are definitely having an impact on the consumer,'' Fisher said.

Crude Oil

Oil prices in early August rose on speculation the conflict between Israel and Hezbollah in Lebanon would spread in the Middle East, the source of almost a third of the world's oil.

The average price of a gallon of regular gasoline jumped to $3.01 in the first two weeks of August, from $2.97 in July, according to the American Automobile Association.

High gasoline prices are limiting disposable incomes, hurting retail sales. Wal-Mart Stores Inc. said sales at stores open more than a year rose 1.7 percent in the three months through July 31, the least in six quarters.

``Customers tell us that they are most concerned about gas prices,'' H. Lee Scott, chief executive of the world's biggest retailer, said on a recorded call on Aug. 15.

Home Depot Inc., the world's largest home-improvement retailer, said earnings this year will be at the low end of its forecast. BJ's Wholesale Club Inc., the third-largest U.S. warehouse retailer, cut its full-year earnings estimate this week.

Retail Sales

Other retailers are doing better. Dillard's Inc., a chain with stores mostly in southern U.S. states, on Aug. 14 posted a second-quarter profit that exceeded analysts' estimates, helped by upscale merchandise such as $245 Dooney & Bourke handbags.

The July unemployment rate rose to 4.8 percent from 4.6 percent, a level that matched the lowest in five years. Average hourly earnings in July rose 0.4 percent for a second month, more than economists forecast, a Labor Department report said Aug. 4.

Initial jobless claims fell by 10,000 to 312,000 in the week that ended Aug. 12, the Labor Department said yesterday. The report indicates demand is strong enough to encourage companies to retain workers, economists said.

``We're in a vibrant labor market,'' said Drew Matus, a senior economist at Lehman Brothers Holdings Inc. in New York.

Housing Market

The housing market, which is cooling after five record years, also is damping consumer confidence. A slowdown in property values makes homeowners feel less wealthy and limits the opportunities for home-equity financing, which was a major source of cash for spending in recent years.

U.S. home construction fell in July to the lowest level in almost two years after higher mortgage rates hurt sales and left builders with bloated inventories, a government report showed this week.

``The housing boom's behind us and the bubble is deflating very rapidly,'' said Joel Naroff, president of Naroff Economic Advisors in Holland, Pennsylvania.

Some economists predict mortgage rates may not rise much further as the slowing economy makes it easier for Fed policy makers to keep holding rates steady. The Fed left the benchmark interest rate unchanged at 5.25 percent on Aug. 8.

Gross domestic product will expand at an average annual rate of less than 2.8 percent in the second half of the year, compared with a 4.1 percent first-half pace, according to the median forecast of 69 economists surveyed from July 28 through Aug. 10.

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

Last Updated: August 18, 2006 10:04 EDT