WASHINGTON (AP) -- Personal incomes plunged in July while consumer spending slowed significantly as the impact of billions of dollars in government rebate checks began to wane.

The Commerce Department reported Friday that personal incomes fell by 0.7 percent in July, the biggest drop in nearly three years and a far larger decline than the 0.1 percent decrease analysts expected.

Consumer spending edged up a modest 0.2 percent, in line with expectations, but far below June's 0.6 percent rise. When the impact of rising prices was factored in, spending actually dropped by 0.4 percent in July, the weakest showing for inflation-adjusted spending in more than four years.

The July performance for incomes and spending reinforced worries that the economy, which posted better-than-expected growth in the spring because of the rebate checks, could stumble in coming months as their impact fades.

Some economists worry that overall economic growth, which rose at a 3.3 percent annual rate from April-June, could come in at less than half that pace in the current quarter, and could actually dip into negative territory in the final three months of this year and the first quarter of 2009.

Back-to-back declines in the gross domestic product, which measures the value of all goods and services produced within the U.S. and is the best barometer of the country's economic health, would meet one rule of thumb for a recession.

A gauge of inflation closely watched by the Federal Reserve remained elevated in July, rising by 0.6 percent. Over the past 12 months, this inflation gauge tied to consumer spending was up 4.5 percent, the biggest year-over-year increase in more than 17 years.

The surge reflected the big increases that have occurred this year in food and energy costs. Excluding food and energy, inflation by this measure was up 0.3 percent in July, and 2.4 percent over the past 12 months, still above the Fed's comfort zone. The central bank is caught in a bind between a sluggish economy and rising inflation pressures.

The 0.7 percent drop in personal incomes followed a 0.1 percent rise in June and a 1.8 percent surge in May. After-tax incomes dropped by an even bigger 1.1 percent in July, following a 1.9 percent decline in June and a 5.7 percent surge in May. All the income figures were heavily influenced by the rebate checks.

Democrats, including presidential nominee Barack Obama, are calling for the government to pass a second stimulus package to guard against the economy slumping into a deep recession.

But President Bush, concerned about the impact the stimulus payments will have on the budget deficit, has resisted those calls, insisting that the rebate payments will continue to support the economy in coming months. The administration is already forecasting that the federal budget deficit for the budget year that begins on Oct. 1 will soar to an all-time high in dollar terms of $482 billion.

The report on consumer spending also showed that personal savings totaled 1.2 percent of after-tax incomes in July, down from a rate of 2.5 percent in June.