A Commerce Department report said the drop in spending - which accounts for two-thirds of US economic activity - came even as incomes rose 0.2 per cent.

The decline in spending was the steepest since Jun 2004, according to officials, and sharper than the average 0.2 per cent decline expected by private economists. Adjusted for inflation, the drop was a steeper 0.4 per cent.

The Sept personal income estimate reflects the effects of Hurricane Ike, which struck the Gulf Coast region, causing losses in rental income and property damage, the department noted.

Incomes however grew a bit more than the consensus forecast of a 0.1 per cent rise, but inflation-adjusted incomes were up just 0.1 per cent.

The monthly report was no surprise, since it came a day after the government report on Jul-Sept gross domestic product (GDP) showing an annualised 3.1 per cent decline in consumer spending in the quarter, the biggest drop since 1980.

The sharp drop in consumer spending, which accounts for two-thirds of US economic activity, drove third-quarter GDP into a 0.2 per cent contraction, confirming most analysts predictions that the world's biggest economy is heading into recession.

'Although this report is old news - in the sense that the data are already embedded in the third-quarter GDP decline - it underscores that we are in a consumer recession,' said Mr John Ryding at RDQ Economics.

Ryding underlined that real consumer spending had declined at a 3.9 per cent annualised rate in the past three months and predicted another sharp decline in the fourth quarter, when retailers realise the bulk of their earnings in the holiday shopping season.

'Conditions for consumer spending in the fourth quarter are not expected to improve, with further downward pressure on employment, consumer confidence and net household worth. As a result, we expect another sharp quarterly decline in real consumer spending,' said Mr Brian Bethune, US economist at IHS Global Insight.

An inflation index linked to the report known as the personal consumption expenditure index increased 0.1 per cent and the core PCE index, excluding food and energy, rose 0.2 per cent.

In August headline inflation fell 'less than' 0.1 per cent and core PCE rose 0.2 per cent, the department said in revised estimates.

The Federal Reserve, which uses the PCE reading to monitor inflationary pressures, is more focused on the currently slowing economy as it faces the stiff headwinds of the worst global credit crisis in seven decades and a real-estate sector slump.

The Fed slashed its key interest rate by a half point for the second time this month on Wednesday, to a historic low of 1.0 per cent, in a bid to unblock credit flows and stimulate growth.

The savings rate rose to 1.3 per cent of disposable income in Sept as consumers slammed their wallets shut in the face of falling home prices, rising unemployment and rising financial turmoil.

The Commerce Department sharply lowered its estimate of the August savings rate to 0.8 per cent, from 1.9 per cent.

The effects of a massive government financial rescue package that sent tens of billions of tax rebate to boost spending faded. The government said a total US$106.7 billion (S$158.64 billion) in tax rebates were distributed in the 2008 fiscal year that ended Sept 30.

The majority of rebates were sent out from late Apr to mid-Jul. -- AFP