Jan. 19 (Bloomberg) -- Americans entered 2007 more confident than at any time in three years as energy prices retreated and a strengthening labor market pushed wages higher.

The Reuters/University of Michigan's preliminary index of sentiment rose to 98 this month, higher than forecast, from 91.7 in December. The gauge averaged 87.3 in 2006.

Gasoline prices are down 28 percent since August, leaving more cash in the pockets of consumers, whose spending accounts for more than two thirds of the economy. The report caps a week of figures showing a rebound in housing, gains in industrial production and a drop in jobless claims to an 11-month low.

``The year is starting off on a solid footing, helped significantly by the dividend of lower oil prices,'' said Lynn Reaser, chief economist at Investment Strategies Group at Bank of America Corp. in Boston. ``The housing slump remains a dampening force, but it has been overwhelmed by these other positive factors.''

Treasury securities weakened after the report, driving the yield on the benchmark 10-year note up 3 basis points to 4.77 percent at 4:30 p.m. in New York.

Companies have also been confident enough in the economy to keep spending. Stronger orders of large equipment including power-plant turbines helped drive a 12 percent increase in fourth-quarter earnings at General Electric Co. Total orders rose 19 percent during the quarter and sales grew 8 percent.

`Psychology'

``There's a lot of optimism among businesses and consumers,'' Federal Reserve Bank of Kansas City President Thomas Hoenig said in a speech today in Kansas City, Missouri. ``That will, of course, be a positive factor in terms of the economy, because an economy is affected by the psychology of the business and the consumer as much as it is the strict number.''

The University of Michigan's expectations index, which some economists view as an indicator of future consumer spending, rose to 88.7, the highest since December 2004, from 81.2.

Still, some economists are skeptical of consumer confidence surveys and their correlation with spending.

``In our view, consumer sentiment and confidence indicators have never been more than loosely correlated coincident indicators of economic activity,'' said Joshua Shapiro, chief economist at Maria Fiorini Ramirez Inc. in New York.

Current Conditions

The 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, rose to 112.5, the highest since July 2005, from 108.1.

``Recent reports do suggest we are getting back to trend growth faster than we would have thought.'' said Nigel Gault, director of U.S. research at Global Insight Inc. in Lexington, Massachusetts. Still, he added, ``I'm not sure we're completely out of the malaise in the economy.''

Consumers in the survey said they expect an inflation rate of 3 percent in one year, compared with 2.9 percent in the last survey.

``It's going to take several months' worth of data to provide statistically convincing evidence of a moderation of inflation,'' Richmond Fed President Jeffrey Lacker said in a speech in Richmond, Virginia, today.

January 2004

This month's reading is the second-highest since December 2000. The sentiment index jumped to 103.8 in January 2004, a month after American forces captured Saddam Hussein in Iraq.

Economists surveyed by Bloomberg News forecast a rise to 92.2, according to the median estimate in a Bloomberg survey of 60 economists. The January figure exceeded the highest estimate in the survey.

Consumer spending is holding up better than economists forecast last year after the biggest housing slump in 15 years slowed growth in the third quarter to a 2 percent rate, less than half the pace in the first half.

Consumer spending grew at a 2.8 percent pace in the July- September period and may have accelerated at a 4 percent rate last quarter, according to a Bloomberg survey of economists taken the first week of January. Spending will likely slow to a 2.7 percent pace this quarter, still above the 2.3 percent rate of economic growth forecast in the survey.

Monetary Policy

With signs that growth is picking up, investors have lowered their expectations that the Federal Reserve will start cutting interest rates this year. Fed policy makers on Dec. 12 voted to hold the benchmark interest rate at 5.25 percent for the fourth straight meeting and forecast a moderate pace of growth ``on balance over coming quarters.''

Reports in recent days suggest the economy may have weathered the worst effects of the slumps in housing and manufacturing. Building permits in December rose for the first time in 11 months, retail sales rose by the most in five months, and industrial production was the strongest since July, the government has reported in the past week.

The economy added a greater-than-expected 167,000 new jobs in December and hourly wages grew 4.2 percent from a year earlier, matching the fastest in six years, the government reported January 5.

Consumers are also feeling better about their finances because of falling prices at the gas pump and rising stock prices.

Gasoline Price

The average price of a gallon of regular gasoline was $2.20 on Jan. 17, about 13 cents lower than at the end of December, according to the American Automobile Association.

Crude oil for February delivery fell to $50.50 a barrel at the close yesterday on the New York Mercantile Exchange. That's down from $62.21 on Dec. 18, and 36 percent below last year's intraday high of $78.40 on July 14. Some of those declines have yet to feed into gasoline prices.

Stocks are also continuing last year's rally. The Standard & Poor's index rose 1.4 percent through Jan. 15 from Dec. 22, when last month's Michigan report was released.

Retail sales in December rose 0.9 percent, more than economists forecast and the biggest increase in five months, the government said Jan. 12. Strong retail sales continued into this month.

Sales at U.S. retail chains climbed 3.4 percent in the first week of January compared with the same week a year earlier, the largest gain since mid-October, as shoppers redeemed holiday gift cards after Christmas, the International Council of Shopping Centers and UBS Securities LLC said in a statement Jan. 9.

Auto sales also perked up at the end of 2006. Vehicle purchases in December rose to a 16.8 million annual pace, the fastest since July, after rising at a 16.1 million rate in November.

To contact the reporter on this story: Bob Willis in Washington at bwillis@bloomberg.net

Last Updated: January 19, 2007 16:51 EST