Inflation outlook makes consumers' mood grim

By Burton Frierson

NEW YORK (Reuters) - U.S. consumer confidence fell to a 28-year low in May, a survey showed on Friday, as soaring prices for food and fuel soured sentiment and pushed long-term inflation expectations to the highest in more than a decade.

The rising expectations conflicted with a government report showing price growth moderated last month. Together, the reports heighten the challenge facing the Federal Reserve, which wants to avoid inflation perceptions becoming reality.

The Reuters/University of Michigan Surveys of Consumers confidence index fell to 59.8 in May, the lowest since 58.7 in June 1980. Its gauge of five-year inflation expectations rose to 3.4 percent, the highest since April 1995.

"Consumers are running scared. These price data are bad for consumers and businesses," said David Wyss, chief economist at Standard & Poor's Ratings Services in New York.

"We are not going to see the economy getting better any time soon. We are still in the early stages of the recession."

The Reuters/University of Michigan index was below April's 62.6 but slightly above Wall Street's median expectation of 59.5 in a Reuters survey of economists.

Its general picture of weakness meshed with a regional barometer that showed business activity in the U.S. Midwest contracted in May for the fourth consecutive month, according to the National Association of Purchasing Management-Chicago.

However, financial markets took some encouragement from the signs of moderating inflation in the government data. It was one factor behind the S&P 500 index ending slightly higher.

Bonds also edged higher, while the dollar slipped versus the euro and yen.

The Fed has staked its monetary policy on the notion that the weak economy will put the squeeze on inflation, with consumers forced to rein in extra spending to keep pace with rising prices of necessities such as food and energy.

This would allow the central bank to keep interest rates low to spur future economic growth without fueling unwanted inflation.

However, any signs that prices are getting out of hand would require higher interest rates, which would pummel stocks and bonds.

The data offered some signs that all was going according to the Fed's plan.

The core personal consumption expenditures price index, which excludes food and energy prices, showed underlying inflation slowed on a monthly basis in April to a modest 0.1 percent, as expected, from 0.2 percent in March.

The core index, which is the Fed's favorite inflation gauge, showed annual price growth held steady last month at 2.1 percent. That is just slightly above the Fed's perceived comfort zone, which tops out at 2 percent.

In addition, U.S. personal spending rose 0.2 percent in April, as forecast. But real spending adjusted for higher inflation was stagnant.

In contrast, the University of Michigan report painted a troubling picture. Its gauge of one-year inflation expectations surged to 5.2 percent -- the highest since February 1982, when the actual consumer inflation rate was above 7 percent.

In April, one-year inflation expectations were at 4.8 percent.

The report heightens worries that the United States could be entering a period of stagflation like the late 1970s and early 1980s, characterized by a sluggish economy and accelerated price growth.

It also calls into question the view of some Fed officials that long-term inflation expectations have remained well anchored despite sky-high commodities prices.

In more signs of problems for a Fed eager to convince Americans that inflation is under control, the Michigan report showed a record-high 55 percent of consumers rate U.S. government economic policy as poor.

"High food and fuel prices have devastated the finances of consumers, with rising concerns expressed across all income groups," the Surveys of Consumers said.

(Additional reporting by Richard Leong; Editing by Dan Grebler)