U.S. consumer spending barely edged up in January as households took advantage of tax cuts to rebuild their savings, suggesting spending would offer only a modest lift to the recovery in the first quarter.

Other data Monday painted a bullish picture of the manufacturing sector, with a gauge of factory activity in the country's Midwest hitting a 22-1/2 year high this month, which should help the economy weather rising oil prices and maintain its steady growth momentum.

The Commerce Department said spending rose 0.2 percent, the smallest increase in seven straight months of gains, after an upwardly revised 0.5 percent increase in December.

The data shows that the manufacturing side continues to be extremely solid, said Omair Sharif, an economist at RBS in Stamford, Connecticut. In contrast, he said, consumer spending would be only a modest driver of growth this year.

We are going to improve as the year goes, but it's going to be a gradual uptick, he said.

New York Federal Reserve Bank President William Dudley, speaking in New York, cautioned against withdrawing support for the economy too soon.

Fed Chairman Ben Bernanke testifies before Congress on Tuesday and Wednesday and is likely to echo Dudley's comments. Some Fed officials have said the central bank should consider paring its $600 billion bond buying program aimed at keeping interest rates low and bolstering the economy.


Consumer spending -- which accounts for 70 percent of U.S. economic activity -- rose at a robust 4.1 percent rate in the fourth quarter, making up the bulk of the economy's 2.8 percent annualized growth pace.

But the rising cost of gasoline and food has begun to eat into household budgets. The spending report showed consumer inflation rose at a relatively brisk 0.3 percent last month.

Taking the higher prices into account, spending actually fell 0.1 percent, the first decline in a year. That prompted some economists to downgrade their spending growth forecasts for the first quarter to as low as a 2 percent rate.

The report, however, offered little evidence that food and energy costs were sparking a broader rise in inflation.

A core inflation gauge closely watched by the Fed edged up just 0.1 percent. In the 12 months through January, this index rose 0.8 percent, just off a record low.

Tax cuts helped lift incomes by 1.0 percent in January, the largest rise since May 2009, as the government began to withhold less for the Social Security retirement program.

The lower tax withholding was part of an $858 billion tax cut package enacted last year. Economists expect the extra income to cushion consumers against high gasoline prices.

With spending tepid and incomes strong, savings jumped to their highest level since August.


Separately, the Institute for Supply Management-Chicago's index of business activity in the Midwest rose to 71.2 -- the highest since July 1988 -- from 68.8 in January as new orders and deliveries and backlogs increased.

A reading above 50 indicates expansion in the regional economy.

The data, combined with other upbeat regional factory surveys, suggested a national manufacturing report Tuesday could show more strength than had been expected. According to a Reuters survey of economists last week, the Institute for Supply Management's index of national factory activity probably rose to 61.0 this month from 60.8 in January.

The big surprise of this recovery is how strong and how robust the manufacturing sector has been, said Kurt Karl, head of economic research at Swiss Re in New York.

The data had a minimal impact on U.S. financial markets, where an announcement by value investor Warren Buffett that he was eyeing major acquisitions put stocks on track for their third straight month of gains.

U.S. government debt prices rose modestly, while the dollar fell to a 3-1/2 month low against a basket of currencies.

A third report showed the recovery continues to elude the housing sector. The National Association of Realtors Pending Home Sales Index, based on contracts signed in January, fell 2.8 percent. Pending home sales lead existing home sales by a month or two.

(Editing by Chizu Nomiyama)