(Adds consumer sentiment, analyst comments, updates markets)
* Core capital goods orders increase 1.0 percent in April
* Core capital goods shipments rise 0.8 percent
* Durable goods orders decline 1.7 percent
By Lucia Mutikani
WASHINGTON, May 25 (Reuters) - New orders for key U.S.-made capital goods increased more than expected in April and shipments rebounded, pointing to a moderate pickup in business spending on equipment after slowing down at the end of the first quarter.
The report from the Commerce Department on Friday added to data on consumer spending in suggesting momentum in the economy. That bolsters expectations the Federal Reserve will raise interest rates next month. The U.S. central bank increased borrowing costs in March and forecast at least two more rate hikes for this year.
"Business investment spending is solid enough to keep the Federal Reserve on the gradual path of interest rate hikes," said Chris Rupkey, chief economist at MUFG in New York. "The economy is firing on cylinders this quarter with both consumers and business investment adding to the mix on economic growth."
Orders for non-defense capital goods excluding aircraft, a closely watched proxy for business spending plans, jumped 1.0 percent last month. The increase in the so-called core capital goods orders reversed March's 0.9 percent drop.
Economists polled by Reuters had forecast core capital goods orders rising 0.7 percent last month. Core capital goods orders increased 6.6 percent on a year-on-year basis.
Shipments of core capital goods rose 0.8 percent last month after falling 0.7 percent in March. Core capital goods shipments are used to calculate equipment spending in the government's gross domestic product measurement.
Business spending on equipment slowed in the first quarter after double-digit growth in the second half of 2017. Moderate growth is expected in the second quarter.
Prices of U.S. Treasuries were trading higher and the dollar rose against a basket of currencies. Stocks on Wall Street fell.
Some economists said the pace of growth in business spending on equipment was disappointing given the Trump administration's $1.5 trillion income tax cut package, which came into effect in January. The government slashed the corporate tax rate to 21 percent from 35 percent.
"Businesses are spending more, but not enough," said Joel Naroff, chief economist at Naroff Economic Advisors in Holland, Pennsylvania. "Given the huge tax cuts in the tax bill, anything less than double-digit increases would be a major disappointment."
There are concerns that protectionist trade policies being pursued by the government, which have resulted in tariffs on some imported goods including washing machines, lumber, steel and aluminum, could hurt business confidence.
A survey early this month showed trade policy as the top concern for manufacturers, with some reporting that "business planning is at a standstill" as a result of the tariffs.
Last month, orders for electrical equipment, appliances and components increased 2.6 percent after rising 2.4 percent in March. Orders for computers and electronic products gained 1.1 percent while those for fabricated metals jumped 2.0 percent. There were also increases in orders for primary metals.
But orders for machinery fell 0.8 percent after decreasing 3.2 percent in March.
Overall orders for durable goods, items ranging from toasters to aircraft that are meant to last three years or more, dropped 1.7 percent in April as demand for transportation equipment tumbled 6.1 percent. That followed a 2.7 percent increase in durable goods orders in March.
Boeing reported on its website that it received only 78 aircraft orders in April compared to 197 in March.
Orders for motor vehicles and parts rose 1.8 percent last month after advancing 0.6 percent in March. Unfilled orders of durable goods rose 0.5 percent in April. They have increased in five of the last six months, which bodes well for manufacturing. Unsold durable goods rose 0.3 percent.
A separate report from the University of Michigan on Friday showed its consumer sentiment index slipped to a reading of 98.0 in May from 98.8 in April. While consumers were upbeat about the labor market, they expected smaller income gains than a month or year ago. They also expected inflation and interest rates to rise in the year ahead.
Though the correlation between consumer sentiment and consumer spending has weakened, worries about income together with rising borrowing costs and prices could restrain consumer spending in the coming months.
"There appears to be some emerging skepticism about whether or not wage gains will actually increase enough to offset expected inflationary pressures and rising interest rates, despite an expectation of continued job market strength," said Jim Baird, chief investment officer at Plante Moran Financial Advisors in Kalamazoo, Michigan. (Reporting by Lucia Mutikani Editing by Paul Simao and Chizu Nomiyama)