(Adds July auto sales figure, updates markets)
* Factory activity slows in July as orders drop
* Consumer spending up 0.1 percent in June
* Personal income unchanged as dividend payments fall
WASHINGTON, Aug 1 (Reuters) - A gauge of U.S. factory activity slid from a near three-year high in July amid a slowdown in new orders and consumer spending barely rose in the prior month, setting the stage for a moderate economic expansion in the third quarter.
That was reinforced by other reports on Tuesday showing motor vehicle sales in July recorded their biggest year-on-year drop in nearly seven years. A plunge in construction spending in June suggested the government could cut its second-quarter GDP growth estimate.
The Commerce Department reported last week that the economy grew at a 2.6 percent annual rate in the April-June period, accelerating from the first-quarter's tepid 1.2 percent pace.
"If the consumer has any say, don't expect any major improvement in growth," said Joel Naroff, chief economist at Naroff Economic Advisors in Holland, Pennsylvania. "Yes, manufacturers are saying things are good, but with vehicle sales trending downward compared to last year, it is likely there is little room for further improvement."
The Institute for Supply Management (ISM) said its index of national factory activity fell to 56.3 last month from 57.8 in June, which was the highest level since August 2014.
A reading above 50 in the ISM index indicates an expansion in manufacturing, which accounts for about 12 percent of the U.S. economy. Manufacturing is slowing as a boost from the energy sector ebbs after a burst in oil well drilling activity.
It is also being hurt by declining automobile production as companies respond to falling sales that have left them with an inventory bloat. Motor vehicle output has dropped for three straight quarters.
General Motors Co reported on Tuesday that its sales fell 15 percent in July from a year ago and rival Ford Motor Co reported a 7.5 percent sales decline. Overall motor vehicle sales dropped 6.1 percent in July to a seasonally adjusted 16.73 million-unit rate from a year ago. That was the largest year-on-year decline since August 2010.
The ISM survey's production sub-index fell 1.8 points to 60.6 last month. Though a gauge of new orders slipped to 60.4 from 63.5 in June, manufacturers were upbeat about demand.
Manufacturers in the chemical, computer and electronic and nonmetallic mineral products sector reported either strong orders growth or demand.
Machinery makers described business as very steady, but said "everyone is waiting till the last minute to place their orders." Electrical equipment, appliances and components manufacturers said they were starting to see better "order entry" and planning on a turnaround for 2018.
While a measure of factory employment dropped two points to 55.2, manufacturers reported employees leaving for other opportunities and some said labor shortages were "pretty universal."
The U.S. dollar rebounded from a 15-month low against a basket of currencies. Prices of U.S. Treasuries also reversed course and ended higher. U.S. stocks rallied, with the Dow Jones Industrial Average hitting a record high.
In a separate report on Tuesday, the Commerce Department said consumer spending, which accounts for more than two-thirds of U.S. economic activity, edged up 0.1 percent in June after a 0.2 percent gain in May.
There was also little sign of inflation. The personal consumption expenditures (PCE) price index, excluding food and energy, increased 1.5 percent in the 12 months through June, after advancing by the same margin in May.
The so-called core PCE is the Federal Reserve's preferred inflation measure. The U.S. central bank has a 2 percent target.
When adjusted for inflation, consumer spending was unchanged in June after rising 0.2 percent in May. June's flat reading points to moderate consumer spending growth in the third quarter. The data was included in last Friday's GDP report.
Since accelerating at a 3.8 percent pace in the second quarter of 2016, consumer spending growth has remained below a 3.0 percent rate, restrained by sluggish income gains.
In June, personal income was unchanged. That was the weakest reading since a 0.1 percent dip in November 2016 and followed a 0.3 percent increase in May. Wages and salaries rose 0.4 percent in June.
Personal dividend income declined 3.0 percent after surging 4.8 percent in May on a boost from Apple Inc. Income at the disposal of households after accounting for inflation fell 0.1 percent, the largest decrease since last December.
In another report, the Commerce Department said construction spending in June tumbled 1.3 percent to $1.21 trillion, the lowest level since September 2016.
Construction spending was weighed down by a 5.4 percent plunge in public investment, which was the biggest decline since March 2002. The drop occurred across federal, state and local governments. Hopes that President Donald Trump's vow to boost infrastructure spending would kick off a construction boom have now largely faded.
"Public construction spending will remain on a soft trend," said Gregory Daco, chief U.S. economist at Oxford Economics in New York. "The decline in construction spending in June points to a downward revision worth roughly two-tenths of a percentage point off of second-quarter real GDP growth." (Reporting by Lucia Mutikani; Editing by Lisa Shumaker; Editing by Paul Simao)