U.S. retail sales, factory output slump; third-quarter growth forecast cut

By Lucia Mutikani

WASHINGTON (Reuters) - U.S. retail sales fell more than expected in August amid weak purchases of automobiles and a range of other goods, pointing to cooling domestic demand that further diminishes expectations of a Federal Reserve interest rate increase next week.

The economic growth outlook also took a hit from other data on Thursday showing a drop in manufacturing output last month. The reports, which extended August's run of weak data, prompted economists to cut their growth estimates for the third quarter.

"With households not buying, manufacturers stopped producing. If the Fed is data dependent, then the next time a hike would likely come is December," said Joel Naroff, chief economist at Naroff Economic Advisors in Holland, Pennsylvania.

The Commerce Department said retail sales declined 0.3 percent after edging up 0.1 percent in July. Sales were up 1.9 percent from a year ago. Excluding automobiles, gasoline, building materials and food services, retail sales slipped 0.1 percent last month after a similar drop in July.

These so-called core retail sales correspond most closely

with the consumer spending component of gross domestic product.

Economists had forecast overall retail sales slipping 0.1 percent and core sales climbing 0.3 percent last month.

Sales were almost broadly weak, rising in only four categories, including clothing stores and restaurants and bars. Receipts at auto dealerships fell 0.9 percent and online sales, whose share has grown in recent years, dropped 0.3 percent.

The Fed will hold its policy meeting next Tuesday and Wednesday. Fed Governor Lael Brainard said on Monday she wanted to see stronger consumer spending data and signs of rising inflation before hiking rates.

The U.S. central bank raised its benchmark overnight interest rate at the end of last year for the first time in nearly a decade, but has held it steady since amid concerns over persistently low inflation.

Financial markets are pricing in a roughly 12 percent probability of a rate hike next week, down from 15 percent before the data, according to the CME FedWatch tool. September rate hike probabilities have been declining since early this month in the wake of a slowdown in job growth in August.

Stocks on Wall Street rose on the diminishing chances of a rate hike next week, while the dollar was little changed against a basket of currencies. Prices for shorter-dated U.S. Treasury debt rose marginally.

MANUFACTURING STRUGGLING

In a second report, the Fed said manufacturing output fell 0.4 percent in August, reversing July's increase. Output was hurt by declines in the production of nondurable goods. While many durable goods industries posted declines of nearly 1 percent or more, motor vehicle assembly increased.

Manufacturing is grappling with the lingering effects of a strong dollar and lower oil prices. Activity in the sector, which accounts for 12 percent of the U.S. economy, has also been undercut by an inventory correction. Regional surveys also suggested factories remained on the back foot in September.

But there was good news from mining, where output rose 1.0 percent in August as oil and gas well drilling increased for a third straight month.

In the wake of the dour reports, the Atlanta Fed lowered its third-quarter GDP estimate by three-tenths of a percentage point to a 3.0 percent annual rate. The economy grew at a 1.1 percent rate in the second quarter.

Even as domestic demand shows some signs of fatigue after surging in the second quarter, layoffs remain very low. A third report from the Labor Department showed initial claims for state unemployment benefits edged up 1,000 to a seasonally adjusted 260,000 for the week ended Sept. 10.

It was the 80th straight week that claims remained below the 300,000 threshold, which is associated with robust labor market conditions. That is the longest stretch since 1970, when the labor market was much smaller.

"Companies remain unwilling to let go of workers, presumably reflecting the difficulty of hiring new workers. In our view, the labor market is tight," said John Ryding, chief economist at RDQ Economics in New York.A fourth report from the Labor Department suggested the strong dollar and cheap oil's dampening effects on producer inflation were ebbing.

The producer price index for final demand was unchanged in August following a 0.4 percent drop in July. Excluding food, energy and trade services, producer prices increased 0.3 percent last month after being unchanged in July.

The so-called core PPI increased 1.2 percent in the 12 months through August, the biggest gain since December 2014, after rising 0.8 percent in July.

(Reporting by Lucia Mutikani; Editing by Andrea Ricci)