Personal income in largest drop in 3 years

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NEW YORK (CNNMoney.com) -- Personal income fell in July by the biggest drop in 3 years after surging the prior two months because of $90 billion in economic stimulus payments.

The Commerce Department said Friday that individual income decreased by 0.7% in July after a 0.1% jump in June and a 1.8% increase in May. Economists polled by Briefing.com were expecting income to fall by 0.2% in July.

Economists were expecting a decrease in income following the temporary boost provided by the stimulus checks.

But the sharp decline was the largest drop off since August of 2005, when personal income plunged by 2.3%, according to the Bureau of Economic Analysis.

While personal income fell, disposable personal income sank even further in July. Disposable personal income - which is what consumers have after they pay taxes - fell by 1.1% in July, after a 1.9% tumble in June. In May, however, disposable income jumped by 5.7%, largely due to the initial wave of stimulus checks.

The stimulus program provided consumers with cash to spend, and in general, Americans spent it, boosting the nation's economy. On Thursday, second-quarter gross domestic product was revised up to 3.3% annual growth, after being initially reported at 1.9%, according to the Commerce Department.

But personal spending in July increased by just 0.2%. That was in line with economists' expectations but lower than the 0.6% increase in consumer spending in June.

Inflation concerns: The uptick in consumer spending was primarily driven by higher prices, however. Individual spending, when adjusted for inflation, actually fell by 0.4% in July, after dipping by 0.1% in inflation-adjusted dollars in June, according to the report.

"Apparently, a large portion of the extra money provided by the rebate checks was eaten up by higher prices at the grocery store or siphoned away by higher prices at the gas pump," wrote Mark Vitner, senior economist at Wachovia, in a note Friday.

The government's stimulus program provided temporary relief, but "now we are losing momentum again," added Robert Brusca, Chief economist at FAO Economics. "You have to be concerned about where we are heading."

Another measure in the report that tracks prices that consumers pay on goods and services, excluding food and energy, rose by 0.3% in July over the previous month.

In addition, the core personal consumption expenditures index - a year-over-year inflation gauge that also excluded food and energy - rose by 2.4% in July from the same month a year ago. Core PCE was 2.3% in June. The Federal Reserve is widely believed to prefer that the core PCE stay in a range of 1% to 2%.

Rising inflation is hurting the struggling economy, and posing a dilemma for the central bank. Brusca said that members of the Fed concerned about inflation "will not take much comfort from" the core PCE number.

Looking forward, Vitner said that lower energy costs in August could potentially be good news for inflation.

"Gasoline prices plummeted in August, which should provide some near-term relief to the inflation figures and real incomes," he wrote.