Retailers posted July sales below analysts' expectations after cutting prices to attract shoppers worried about high unemployment, a strategy that bodes ill for the back-to-school season.

The increased discounting that began in June and continued last month is reminiscent of the troubles that plagued retailers during the worst of the recession.

We're back to a game of chicken between consumers and retailers over discounts, said David Bassuk, who leads consulting firm AlixPartners' global retail practice. We're going to have a slow, painful back-to-school season.

At the trough of the recession in 2008, same-store sales declined sharply, leading to the weakest holiday season in decades. Any renewed weakness in consumer spending, which accounts for two-thirds of the U.S. economy, could cast a shadow on the recovery.

The 28 retailers tracked by Thomson Reuters reported a 2.9 percent rise in July sales at stores open at least one year, missing Wall Street forecasts of 3.1 percent. Of those, 17 reported lower-than-expected sales, while nine beat estimates.

July is typically a slow month for retailers as they try to clear out summer goods and prepare for the back-to-school season, but it is seen as an early indicator of autumn sales.

Some of July's pain came from back-to-school shoppers holding out to see whether retailers will cut prices in August and September, analysts said.

That prompted the International Council of Shopping Centers to forecast same-store sales would be up 3 percent in August.

Every time I see a sales (advertisement), I try to see who has a better sale, said Dee Archibald, a sales representative in Chicago who was shopping for back-to-school items on Thursday. You really want your money to go as far as possible.

July was the 11th straight month of improving sales, compared with a year-earlier drop of 5.1 percent, according to Thomson Reuters data.

But the results follow a weak June, when retailers also disappointed amid signs that price-cutting was creeping up.

We are now in an environment where the dollars in consumers' pockets are fewer, so the competition for those dollars has increased, said Lawrence Creatura, portfolio manager at Federated Clover Investment Advisors.

Analysts have also noted that year-earlier comparisons will get tougher in the fall and the key holiday selling season.

U.S. consumer sentiment hit its lowest level in nine months in July, according to Thomson Reuters/University of Michigan's Surveys of Consumers. [ID:nN30173680]. On Thursday, the government reported that new U.S. claims for unemployment benefits unexpectedly rose in the latest week. [ID:nN05245807].

The Standard & Poor's Retail Index <.RLX> was up 0.2 percent in afternoon trading. Shares of Macy's Inc , whose sales beat Wall Street forecasts, rose 1.4 percent. Among retailers that missed expectations, J.C. Penney Co Inc shares fell 7.3 percent, and Nordstrom Inc was down 2.8 percent even though it was one of the biggest sales gainers with a 7.6 percent July same-store sales increase.


Some retailers that did manage to eke out gains did so by taking customers from rivals, rather than from an increase in overall spending.

It's a zero-sum game, said KeyBanc Capital Markets analyst Ed Yruma. The retailers that focused on price did better on a relative basis.

Department store operators Macy's, Kohl's Corp and upscale Saks Inc all beat forecasts, benefiting from efforts to ramp up exclusive lines.

Macy's reported a 7.3 percent increase in July same-store sales, crediting a strong performance by its upscale Bloomingdale's chain and its program that allows stores to choose merchandise to cater to local tastes.

But rivals JCPenney and Dillards Inc reported unexpected same-store sales declines.

Teen apparel retailers suffered some of the worst disappointments, as a large build-up in inventory led to discounting. For example, Hot Topic Inc sold fewer higher-ticket items and increased promotional spending.

Warehouse club operator Costco Wholesale Corp benefited from consumers' anxiety about the economy, beating forecasts with a 6 percent same-store sales jump.

But other discount chains such as Target Corp and BJ's Wholesale Club Inc missed, despite showing strength in staples such as food.

Drugstore chain operators Walgreen Co and Rite Aid Corp in the past week both reported disappointing same-store sales for July, citing sales of lower priced-generic drugs and decreased sales of flu remedies.

(Reporting by Phil Wahba; Additional reporting by Brad Dorfman, Emily Stephenson, and Dhanya Skariachan; Editing by Lisa Von Ahn and Gerald E. McCormick)