Sales at U.S. retailers unexpectedly fell in July and the number of workers filing new claims for jobless benefits rose last week, indicating the recession-hit economy faced a bumpy recovery.

A Commerce Department report on Thursday showed total retail sales edged down 0.1 percent after increasing 0.8 percent in June, compared with market forecasts for a 0.7 percent gain.

Analysts had expected a boost in retail sales from the government's cash for clunkers program, which gives consumers cash to swap aging gas-guzzlers for new, more fuel efficient models.

Excluding motor vehicles and parts, sales fell 0.6 percent in July after rising 0.5 percent the prior month.

A separate report from the Labor Department showed first-time applications for state unemployment insurance benefits climbed 4,000 to a seasonally adjusted 558,000 last week.

Consumers have cut spending every month. The big surprise is that we thought 'cash-for-clunkers' was going to add to GDP but instead it took away spending elsewhere, said Christopher Low, chief economist, at FTN Financial in New York.

It's tough to say the recession is over. We have transitioned from steep decline to a mild decline but we are still declining.

The Federal Reserve, in leaving short-term interest rates near zero on Wednesday, said economic activity was leveling out. But it noted that sluggish income growth and continued job losses were constraining household spending, which was showing signs of stabilizing.

Consumer confidence is expected to be slightly higher for August in the Reuters/University of Michigan Surveys of Consumers due on Friday.

FORECLOSURES SURGE

There was more bad news on the home foreclosures front, where RealtyTrac reported that U.S. home loans failed at a record pace in July despite ongoing federal and state programs to avoid foreclosures.

Foreclosure activity jumped 7 percent in July from June and 32 percent from a year earlier as one in every 355 households with a loan got a foreclosure filing, RealtyTrac said.

U.S. government debt prices were higher after the surprise drop in retail sales. Major U.S. stock indexes were lower on the weak data, while the dollar fell against the yen.

Interest rate futures lowered the chances of an increase in the Fed's benchmark overnight interest rate to 42 percent in January from 46 percent before Thursday's data.

The retail sales data cast a shadow over an anticipated rebound in consumer spending in the current quarter. Spending, which accounts for over two-thirds of U.S. economic activity has been pressured by high unemployment.

In another indication of weak consumer demand, Wal-Mart Stores Inc on Thursday said sales at stores open at least a year fell unexpectedly in the second quarter and its chief executive said the economy will remain challenging in the short term.

Consumer spending fell at a 1.2 percent annual rate in the second quarter after edging up 0.6 percent in the January-March period. Despite signs the worst recession in over 60 years was winding down, companies have been reluctant to hire, though the pace of layoffs has slowed down markedly.

It looks like there is underlying weakness. The American consumer has yet to join the party, said Kevin Flanagan, fixed-income strategist for Global Wealth Management at Morgan Stanley in Purchase, New York.

GREEN SHOOTS IN GERMANY, FRANCE

However, there were signs the global economy was beginning to perk up. Germany and France reported a surprise return to economic growth during the second quarter, ending their recessions earlier than many policymakers and economists expected.

In the United States, the decline in July retail sales was partially caused by gasoline station sales falling 2.1 percent, reflecting a retreat in gasoline prices during the month, after surging 6.3 percent in June.

Excluding gasoline, retail sales nudged up 0.1 percent.

But there was some ray of hope for the economy in the Labor Department report. The number of people collecting long-term unemployment benefits slipped by 141,000 to 6.20 million in the week ended August 1, the lowest level since mid-April.

The insured unemployment rate dipped to 4.7 percent from 4.8 percent.

Another report from the Commerce Department showed U.S. business inventories fell 1.1 percent in June after a 1.2 percent decline the prior month. Business sales rose 0.9 percent in June, advancing for the first time since July last year, after being flat in May.

(Additional reporting by Mark Felsenthal; Editing by Neil Stempleman)

Retail sales Unemployment Fall