Retail sales posted a surprise fall in July, as the effect of the Government cash stimulus faded, giving the Reserve Bank more reason to delay interest rises. Home loans also dropped in July.

Retail turnover dropped by 1 per cent in July to $19.6 billion from $19.8 billion in June, when they fell a revised 0.8 per cent, seasonally adjusted, according to the Australian Bureau of Statistics. Analysts had expected sales would increase 0.5 per cent in July.

The disappointing spending drop follows a run of mostly upbeat economic news including a gauge of consumer confidence out today hitting a two-year high. It was first back-to-back drop in retail spending since the start of 2008.

''The main implication is that we're not going to get an October rate hike," said ICAP economist Adam Carr. Markets now rate the chance of a RBA rate rise at just one-in-four, following the retail sales data release, down from a 40 per cent chance earlier today.

The dollar sank by more than half a US cent from 86.55 US cents to 85.96 US cents on the news, partly reversing a rally in the currency in recent days. Stocks also gave up early gains to be flat in recent trading.

Nonetheless, Mr Carr said the spending pull-back did not suggest a deteriorating trend in consumer spending. June retail sales, for instance, were revised upward from an original drop of 1.4 per cent.

July's retail result was dragged lower by a 1.9 per cent slide in food sales, seasonally adjusted, while household goods shrank 3.6 per cent.

Mr Carr said the drop in sales is likely to have a limited overall effect for the economy because food isn't considered a discretionary item and the fall in household goods sales offset a gain in June.

Home loans

Housing finance offered additional cause to query the strength of Australia's economic pick-up.

Home loans fell by 2 per cent in July, seasonally adjusted, from a revised 0.4 per cent increase in June, snapping nine months of gains aided by low interest rates and fiscal stimulus.

The poor home loans and retail sales figures took some of the gloss off a strong reading on consumer confidence, also released today.

The Westpac Melbourne Institute consumer sentiment index showed a 5.2 per cent rise in September, with the index hitting its highest level since July 2007.

''A soft retail sales print and the fall in housing finance approvals in July will overshadow the continuing surge in consumer confidence,'' said RBC Capital Markets Su-Lin Ong.

The strong consumer confidence figure was helped by news earlier this month that Australia's economy expanded a better-than-expected 0.6 per cent in the June quarter, following a 0.3 per cent gain in March quarter.

The back-to-back GDP growth allowed the nation to skirt the recession dogging most of the rest of the developed world since the global financial crisis deepened more than a year ago.

Consumer sentiment has also been buoyed by a rising stock market since March, while house prices - an even larger component of most households' wealth - have also resumed their increases in most localities.

Stimulus debate

Even as consumers gain in optimism, though, the weakness in actual spending in July is likely to fan debate about how well the economy is really travelling.

''The data shed only limited light on one of the RBA's key questions - how well will consumption and housing hold up as the fiscal stimulus fades?'' Ms Ong wrote in a note to clients.

''The lingering uncertainty suggests that the RBA may be patient in beginning to lift the cash rate as it awaits further data.''

Politicians have weighed into the economic argument this week, as parliament resumed. The Federal Opposition has demanded the Government curb its stimulus spending to avoid running up unnecessary debt as the economy fares better than expected. The Government says it's too early to pull back without ''pulling the rug out'' from under the recovery.

Jobs next

Consumers' confidence, and their willingness to splurge in the shopping malls, hinges to a large degree on how employment holds up.

The ABS will give us an update of the job market tomorrow when it reveals labour force details for August.

The jobless rate in July rose to 5.8 per cent, with economists predicting the tally ticked up modestly to 5.9 per cent last month.

Recent unofficial jobs data, such as the August ANZ Bank job advertisements survey, rose for the first time since April 2008.

The bullish forward indicator has raised hopes for the future of the job market in Australia, although unemployment is still tipped to increase to as high at 7 per cent by the end of 2010.

Also, the Government's Department of Employment and Workplace Relations Services monthly leading indicator of employment rose for the third straight month in September to -0.962 from -1.123 in August.

"The indicator is tentatively foreshadowing a quickening in the pace of employment growth to above its (downwardly revised) long-term trend rate of 1.9 per cent per annum," DEEWR said.

Grinch Stevens

IG Markets market analyst Cameron Peacock said July's retail sales were "confirmation that the consumer is still very fragile and likely to be become extremely spend conscious as and when stimulus measures are unwound."
 
"A 2009 rate hike, while priced in by markets, could see Glenn Stevens labelled the 'Grinch that stole Christmas','' he said.
 
Such a move would add $40 to the average monthly payment on a typical $300,000, 25-year home loan.

While the chances of a rate rise eased for October, the probability for rate rises over the coming year also eased back. Investors now expect official rates to rise 1.75 percentage points, to 5 per cent by next September, less than the 2 percentage jump predicted before the retail sales figures were released.

The Reserve Bank currently has the interest rate at the "emergency" level of 3 per cent, although RBA governor Stevens has hinted at the need to consider hiking rate in coming months, to prevent excess speculation in the housing market.

czappone@fairfax.com.au

BusinessDay