Retail sales fall but consumer sentiment strong

The drop in sales reported by the Commerce Department on Friday followed last week's data showing a step back in private hiring in May, but analysts still saw little risk of the economy slipping back into recession.

The report is not evidence that the economy is getting ready for a double-dip or that consumers, facing headwinds of double-digit unemployment and bank credit restriction, are taking their ball and going home, said Chris Rupkey, chief financial economist at Bank of Tokyo/Mitsubishi in New York.

Total retail sales dropped 1.2 percent in May, weighed down by a record decline in receipts at building materials suppliers, after rising 0.6 percent in April. Financial markets participants had forecast retail sales increasing 0.2 percent last month.

Retail sales, which had risen for seven straight months, were up 6.9 percent compared to May last year.

In a separate report, the consumer sentiment index rose to 75.5 from 73.6 at the end of May, according to the Thomson Reuters/University of Michigan's Surveys of Consumers. That was above market expectations for an increase to 74.5.

The data offered some reassurance on the economic recovery after the surprise drop in retail sales.

This reinforces the view that what moved sales in May was the unwinding of incentives to buy energy-efficient appliances, and other issues like weather, the price of gas, and so forth, said Nigel Gault, chief U.S. economist at IHS Global Insight in Lexington, Massachusetts.

If consumers were getting panicked, you'd have expected to see more worry showing up here.

U.S. stock indices pared losses Friday morning after the sentiment data, while prices for government debt held gains. The U.S. dollar edged higher against the yen and the euro.

HIGH UNEMPLOYMENT

In data published last Friday private businesses unexpectedly held back on hiring in May after expanding payrolls for two months, a trend which could undermine recovery from the worst recession since the 1930s.

Restoring the economy to health is a key priority for President Barack Obama and voter anguish over the slow pace of the recovery could inflict heavy losses on the Democratic Party in November's Congressional elections.

Consumer spending accounts for about 70 percent of U.S. economic activity, but with the unemployment rate near 10 percent, households' spending habits have become more cautious than during previous recoveries.

Retail sales last month were dragged downed by a record 9.3 percent drop in receipts from building materials and garden equipment suppliers, which could reflect a drop in construction following the end of a popular homebuyer tax credit.

Motor vehicle and parts receipts also fell 1.7 percent, although dealers reported a rise in sales.

Excluding autos, sales fell 1.1 percent in May, the largest decline in 14 months, after rising 0.6 percent in April. Markets had expected sales excluding autos to gain 0.1 percent.

However, core retail sales -- which exclude autos, gasoline and building materials -- rose 0.1 percent after falling 0.2 percent in April. Core sales correspond most closely with the consumer spending component of the government's gross domestic product report.

Clothing and clothing accessories sales dropped 1.3 percent, while gasoline receipts fell 3.3 percent, the largest decline since March 2009.

There were a few bright spots in the report, with sales at sporting goods, hobby and book stores rising 0.4 percent in May after falling 1.3 percent in April.

Receipts at electronics and appliance stores increased 0.6 percent, reversing the prior month's fall.

In another report, the Commerce Department said U.S. business inventories hit a 10-month high in April, while sales were at their highest level since October 2008.

Inventories are a key component of gross domestic product changes over the business cycle and the rebuilding of merchandise stock from record low levels is one of the key drivers of the economy's recovery.

(Additional reporting by Ellen Freilich and Richard Leong, Editing by Chizu Nomiyama)