WASHINGTON - CONSUMERS facing rising unemployment kept their spending unchanged in August even though incomes rose, according to a government report Monday that showed optimism about the economy's direction was fading.

The Commerce Department said consumer spending was flat in August after barely edging up by a revised 0.1 per cent in July, a much weaker outcome than forecast by Wall Street economists surveyed by Reuters who had a 0.2 per cent spending rise.

Incomes from wages and salaries and all other sources rose by 0.5 per cent in August, largely reversing July's revised 0.6 per cent drop and well ahead of forecasts for a smaller 0.2 per cent gain.

'Consumers seem to have hit the foxholes,' said Joel Naroff, president of Naroff Economic Advisors in Holland, Pennsyvlania. Hours later, Congress rejected a proposed US$700 billion (S$1 trillion) bailout package for US financial firms, sending a fresh jolt of fear for the future through markets.

The Dow Jones Industrial Average plummeted 777.68 points, or nearly 7 per cent, to end at 10,365.45 while the high tech-laden Nasdaq Composite Index lost 199.61 points to 1,983.73, a drop of more than nine per cent.

Both indexes finished well off their day's lows, hit after the shock rejection vote by the House in early afternoon.

Consumer spending on goods and services fuels about two-thirds of US economic activity so the economy is widely predicted to slow in coming quarters.

In the second-quarter report on gross domestic product issued last Friday, consumer spending already was revised down to a 1.2 per cent annual rate from 1.7 per cent and is likely to keep losing momentum.

'It looks like we are poised to see a real-term decline in personal consumption and that will likely result in a negative GDP number in the third quarter,' cautioned James O'Sullivan, economist at UBS Securities in Stamford, Connecticut.

Separately, the Dallas Federal Reserve Bank said its index of manufacturing activity weakened sharply in September, falling to -39.6 from -18.8 in August though some of the drop likely stemmed from Hurricane Ike causing temporary factory closings.

Despite higher August incomes, consumers facing higher prices for gasoline and other items were unable to save more.

The personal savings rate dropped to 1 per cent from 1.9 per cent in July.

Meanwhile, the report pointed to persistent inflation pressures. The personal consumption expenditures index on a year-over-year basis rose 4.5 per cent in August, only barely below the 4.6 per cent rise posted in July.

Core prices that exclude food and energy were up 2.6 per cent - the highest rate since the beginning of 1995.

Core PCE was up 0.2 per cent from July, in line with expectations. -- REUTERS