By Lucia Mutikani
WASHINGTON (Reuters) - U.S. factory activity slowed in April while consumer spending was unchanged in March and a key inflation measure recorded its first monthly drop since 2001, but economists still expect an interest rate increase in June as the labor market tightens.
The weak reports on Monday came ahead of the Federal Reserve's two-day policy meeting on Tuesday. Economists said policymakers were likely to view the raft of soft data as temporary. The U.S. central bank is not expected to raise interest rates at the end of the meeting on Wednesday.
"We don't expect that will prevent the Fed from hiking interest rates again at the June meeting, at least not as long as employment growth rebounds in April and May," said Paul Ashworth, chief U.S. economist at Capital Economics in Toronto.
The Institute for Supply Management (ISM) said its index of national factory activity dropped to a four-month low of 54.8 in April from a reading of 57.2 in March. A reading above 50 indicates an expansion in manufacturing, which accounts for about 12 percent of the U.S. economy.
The ISM index had risen since last November, scaling a 2-1/2-year high in February, amid optimism over President Donald Trump's pro-business policy proposals.
It has declined in the last two months and some economists say the retreat probably reflects caution among business as they await implementation of the proposals. The Trump administration last week proposed a tax plan that includes cutting the corporate income tax rate to 15 percent from 35 percent, but offered no details.
"The sugar high is wearing off," said Tim Quinlan, a senior economist at Wells Fargo Economics in Charlotte, North Carolina.
The manufacturing recovery is being supported by rising oil prices, which saw spending on mining exploration, wells and shafts surging at a record 449 percent rate in the first quarter.
Last month, nearly every sub-index of the ISM index fell. A measure of new orders received at factories tumbled to a five- month low. A gauge of factory employment dropped to its lowest level since October, which could pose a risk to an expected rebound in job growth in April.
U.S. stocks were little changed as gains in technology stocks, led by Apple (AAPL.O), countered the weak reports. Prices for U.S. Treasuries fell, while the dollar held mostly steady against a basket of currencies.
INFLATION DIP SEEN TEMPORARY
The Fed lifted its overnight interest rate by a quarter of a percentage point in March, in a nod to a strong labor market that is near full employment, and has forecast two more hikes this year.
The consumer spending data was included in last Friday's first-quarter gross domestic product report, which showed the economy growing at a 0.7 percent rate - the weakest performance in three years.
In March, the personal consumption expenditures (PCE) price index excluding food and energy slipped 0.1 percent, the first and largest drop since September 2001, after increasing 0.2 percent in February. The drop reflected declines in the prices of automobiles and mobile phone services.
In the 12 months through March, the so-called core PCE price index increased 1.6 percent, the smallest gain since last July, after advancing 1.8 percent in February. The core PCE is the Fed's preferred inflation measure and is below the central bank's 2 percent target.
"We view much of the weakness in March as driven by one-off factors and expect inflation to firm on a monthly basis in the very near term," said Rod Martin, an economist at Barclays in New York. "We continue to see services price pressures as firming further in the coming quarters."
With price pressures subsiding, inflation-adjusted consumer spending, which accounts for more than two-thirds of U.S. economic activity, increased 0.3 percent in March, ending two straight months of decline. That bodes well for consumer spending in the second quarter.
Consumption will likely be supported by rising wages. Private sector wages recorded their biggest increase in 10 years in the first quarter.
In March, income gained 0.2 percent after rising 0.3 percent in February. Income at the disposal of households after accounting for inflation increased 0.5 percent, the biggest gain since December 2015. Savings increased to a one-year high of $849.1 billion from $819.0 billion in February.
(Reporting by Lucia Mutikani; Editing by Chizu Nomiyama and Andrea Ricci)