Consumer sentiment deteriorated in early July to the lowest level since March 2009 on increasing pessimism over falling income and rising unemployment, a survey released on Friday showed.

Confidence in government economic policies also curdled, the Thomson Reuters/University of Michigan survey showed. U.S. lawmakers are wrangling over a budget deal that would allow the government to raise the debt ceiling -- needed so the United States can fund its obligations next month.

The preliminary reading for the consumer sentiment index dropped to 63.8 in July from 71.5 the month before, falling far short of expectations of an increase to 72.5, according to a Reuters poll of economists.

The survey's barometer of current economic conditions fell to 76.3, the lowest since November 2009, from 82.0. The gauge of consumer expectations was also at its lowest since March 2009, tumbling to 55.8 from 64.8.

Whenever the Expectations Index has been this low in the past, the economy has been in recession, survey director Richard Curtin said in a statement.

Nonetheless, one month's data is insufficient to signal a renewed downturn, particularly if a last-minute agreement on the debt ceiling results in a partial restoration of confidence.

U.S. stocks cut gains immediately after the report, while Treasury prices pared losses and the euro fell to a New York session low against the dollar.

Overall, the data suggests real consumer spending in the second half of the year may be barely higher than the first half, the survey said.

Twice as many consumers reported hearing about new job losses compared with job gains, while half of all consumers said the economy had recently worsened. Last week, data showed the economy added a scant 18,000 jobs in June.

We remain in a very slow recovery with extraordinarily grudging employment. The public at large still feels the recovery is, at best, a neutral factor, said Patrick O'Keefe, director of economic research at J.H. Cohn in New York.

They're not seeing a lot of benefits.

The proportion of consumers that rated government economic policies as poor rose to 52 percent in early July, up from 40 percent in June.

The inflation outlook improved with the survey's one-year inflation expectation easing to its lowest level since February at 3.4 percent from 3.8. The five-to-10-year inflation outlook fell to 2.8 percent from 3.0 percent.

(Reporting by Leah Schnurr; additional reporting by Ryan Vlastelica; Editing by Padraic Cassidy)