U.S. consumer spending slows, but inflation is rising

(Adds sentiment data, analyst comments, updates markets)

* Consumer spending increases 0.1 percent in February

* Inflation-adjusted consumer spending slips 0.1 percent

* PCE price index rises 2.1 percent from year ago

* Core PCE price index increases 1.8 percent year-on-year

By Lucia Mutikani

WASHINGTON, March 31 (Reuters) - U.S. consumer spending barely rose in February amid delays in the payment of income tax refunds, but the biggest annual increase in inflation in nearly five years supported expectations of further interest rate hikes this year.

The slowdown in consumer spending reported by the Commerce Department on Friday is, however, likely to be temporary with consumer confidence at a more than 16-year high and a tightening labor market pushing up wage growth.

"Given the weather-related weakness in utilities spending as well as some delays in tax refunds for low- and middle-income earners in February, we expect consumer spending to strengthen in the quarters ahead," said Eugenio Aleman, a senior economist at Wells Fargo Securities in Charlotte, North Carolina.

The Commerce Department said consumer spending, which accounts for more than two-thirds of U.S. economic activity, edged up 0.1 percent. That was the smallest gain since August and followed an unrevised 0.2 percent rise in January.

Economists had expected a 0.2 percent increase. The government delayed the issuing of tax refunds this year as part of efforts to combat fraud.

Spending last month was held back by a 0.1 percent dip in purchases of big-ticket items like automobiles. While unseasonably warm weather lowered households' heating bills, it restricted spending growth last month.

Weak consumer spending resulted in the Atlanta Federal Reserve trimming its first-quarter economic growth estimate by one-tenth of a percentage point to a 0.9 percent annualized rate. Gross domestic product increased at a 2.1 percent rate in the fourth quarter, stepping down from the July-September quarter's brisk 3.5 percent pace.

Despite signs of moderate growth, economists expect the Federal Reserve will raise interest rates at least twice more this year. The U.S. central bank raised its benchmark overnight interest rates by a quarter of a percentage point this month.

Other data on Friday showed the University of Michigan's consumer sentiment index slipping to a reading of 96.9 in March from 97.6 earlier in the month. The final reading was a touch higher than February's 96.3. A report from the Conference Board this week showed its consumer confidence index surging in March to its highest reading since December 2000.

The dollar was trading slightly higher against a basket of currencies, while U.S. stocks fell marginally as investors skimmed profits off recent gains. Prices for U.S. government bonds rose modestly.

INFLATION PRESSURES BUILDING

Even (Taiwan OTC: 6436.TWO - news) with economic growth slowing at the start of the year, inflation is rising. The personal consumption expenditures (PCE) price index gained 0.1 percent last month after jumping 0.4 percent in January.

That lifted the year-on-year rate of increase in the PCE price index to 2.1 percent, the biggest gain since April 2012. The PCE price index rose 1.9 percent in January.

Excluding food and energy, the so-called core PCE price index increased 0.2 percent last month after rising 0.3 percent in January. In the 12 months through February, the core PCE price index increased 1.8 percent after a similar gain in January.

The core PCE is the Federal Reserve's preferred inflation measure and is running below its 2 percent target. Inflation is now in the upper end of the range that Fed officials in March felt would be reached this year.

"There is nothing in this report that suggests the Fed should pause in June in its gradual renormalization of monetary policy but the Fed will look closely at the evolution of core inflation over the next two months in making that decision," said John Ryding, chief economist at RDQ Economics in New York.

Rising price pressures are also eating into consumer spending. When adjusted for inflation, consumer spending fell 0.1 percent in February after declining 0.2 percent in January.

That was the first back-to-back monthly decline in real consumer spending since April 2009. Personal (LSE: PGH.L - news) income rose 0.4 percent last month after advancing 0.5 percent in January. Wages increased 0.5 percent, the biggest gain in five months.

Income at the disposal of households after accounting for inflation increased 0.2 percent after dipping 0.1 percent in January. Savings (Shenzhen: 300056.SZ - news) rose to a five-month high of $808.0 billion from $770.9 billion in January.

Rising incomes and higher savings bode well for future consumer spending.

(Reporting by Lucia Mutikani; Editing by Andrea Ricci and Matthew Lewis)