Weak U.S. retail sales reinforce Fed caution on rate hikes

By Lucia Mutikani

WASHINGTON (Reuters) - U.S. retail sales unexpectedly fell in March as households cut back on purchases of automobiles and other items, further evidence that economic growth stumbled in the first quarter.

Other data on Wednesday showed a surprise drop in producer prices last month as rising energy prices were offset by a decline in the cost of services. The two reports suggested the Federal Reserve will probably not raise interest rates until later this year.

"The data solidifies the well-entrenched narrative of a very weak first quarter for the U.S. economy. For the Federal Reserve ... it argues for continued caution," said Millan Mulraine, deputy chief economist at TD Securities in New York.

The Commerce Department said retail sales declined 0.3 percent last month, confounding economists' expectations for a 0.1 percent gain. They were unchanged in February.

Retail sales excluding automobiles, gasoline, building materials and food services ticked up 0.1 percent last month after edging up 0.1 percent in February. These so-called core retail sales correspond most closely with the consumer spending component of gross domestic product.

March's weak numbers implied that consumer spending lost steam after robust gains in 2015, and put consumption on a slow path heading into the second quarter. Consumer spending accounts for more than two-thirds of U.S. economic activity.

"Consumer activity, which has been the primary driver of economic activity, in the wake of the sluggishness in the industrial sector, has lost momentum," said Lewis Alexander, chief economist at Nomura Securities in New York. "The weak numbers for March will probably set a lower jumping-off point for personal spending in the second quarter."

U.S. financial markets were little moved by the data as investors focused on strong trade data from China. The dollar rose against a basket of currencies and U.S. stocks were trading higher. Prices for shorter-dated U.S. Treasuries fell slightly.

TAME INFLATION

The retail sales report added to recent data on trade and business spending in suggesting the economy hit a soft patch in the first three months of the year. That was reinforced by a second report from the Commerce Department showing a dip in business inventories in February.

GDP growth estimates for the first quarter are currently as low as a 0.2 percent annualized rate. The economy expanded at a 1.4 percent pace in the fourth quarter.

In a third report, the Labor Department said its producer price index slipped 0.1 percent last month after dropping 0.2 percent in February. In the 12 months through March, the PPI dipped 0.1 percent after being unchanged in February.

Economists had forecast the PPI advancing 0.2 percent last month and gaining 0.3 percent from a year ago.

Soft producer prices point to overall inflation remaining below the Fed's 2 percent target for a while. Tame inflation is a key factor in the U.S. central bank's policy of gradually raising interest rates even as the labor market tightens.

The Fed lifted its benchmark overnight interest rate in December for the first time in nearly a decade and policymakers signaled last month that there would be two more rate hikes this year.

The Fed's policy-setting committee will meet next on April 26-27. Market-based measures of Fed policy expectations have priced out a rate hike at that meeting and have almost eliminated the chances of a move in June, according to CME Group's FedWatch. It currently gives a 44 percent probability of a rate increase in November and a 57 percent chance in December.

Retail sales remain soft despite a strengthening labor market, which is starting to boost wages. Part of the weakness could be due to a stock market sell-off that hurt consumer sentiment early this year. The value of sales is also being restrained by low prices, as retailers offer huge discounts to clear unwanted merchandise clogging up warehouses.

"Consumers have been spooked by the recent turmoil in the stock market and decided that it is probably better to put some money aside and slow down their spending," said Chris Christopher, an economist at IHS Global Insight in Lexington, Massachusetts.

Auto sales dropped 2.1 percent last month, the largest decrease in just over a year. Households are buying fewer automobiles after record purchases last year.

Receipts at service stations recorded their biggest gain in nine months as gasoline prices turned higher. Sales at clothing stores and online retailers fell.

Americans also spent less at restaurants and bars, but increased purchases of sporting goods as well as electronics and appliances. Sales of building materials and garden equipment jumped.

(Reporting by Lucia Mutikani; Editing by Paul Simao)