The July dip was the first setback following two months of modest sales gains. Excluding autos, sales fell 0.6 percent, worse than the 0.1 percent rise economists had forecast.
Households are working to pay down debt and add to savings, longer-term trends along with little job growth making it "probable that the U.S. consumer will not be much of a help during the early stages of the economic recovery," Joshua Shapiro, chief U.S. economist at consulting firm MFR Inc., wrote in a note to clients.
The Labor Department said initial claims increased to a seasonally adjusted 558,000, from 554,000 the previous week. Analysts expected new claims to drop to 545,000, according to Thomson Reuters.
The number of people remaining on the benefit rolls, meanwhile, fell to 6.2 million from 6.34 million the previous week. Analysts had expected a smaller decline. The continuing claims data lags initial claims by one week.
The four-week average of initial claims, which smooths out fluctuations, rose by 8,500 to 565,000. That reverses six straight weeks of decline.
A weak job market hurt sales last month. Gas station sales plunged 2.1 percent in July, due more to falling pump prices than weak demand. Excluding that drop, retail sales would have posted a modest 0.1 percent increase.
Department store sales fell 1.6 percent and the broader category of general merchandise stores, which includes big chains such as Wal-Mart Stores Inc. and Target Corp., posted a decline of 0.8 percent.
Wal-Mart on Thursday reported virtually flat second-quarter income compared with a year ago, but the results beat Wall Street expectations and the world's largest retailer raised the low end of its profit outlook as a series of cost-cutting moves draw frugal shoppers away from rivals.
Still, the July weakness in overall retail sales highlighted worries about the potential strength of the recovery from the recession. Consumer spending accounts for about 70 percent of total economic activity.
"Households are in no position to drive a decent economic recovery," Paul Dales, U.S. economist at Capital Economics, wrote in a note to clients.
While there have been recent signs of stability in the U.S. housing market after three years of plunging prices, record foreclosures persist. The number of U.S. households on the verge of losing their homes rose 7 percent in July, as the foreclosure crisis continued to outpace government efforts to limit the damage.
Foreclosure filings rose 32 percent from the same month last year, RealtyTrac Inc. said Thursday. More than 360,000 households, or one in every 355 homes, received a foreclosure-related notice. That's the highest monthly level since the foreclosure-listing firm began publishing the data more than four years ago.
The Federal Reserve on Wednesday delivered a more upbeat assessment of the economy. The central bank held interest rates at record lows and said it would slow the pace of an emergency rescue program to buy $300 billion worth of Treasury securities, shutting it down at the end of October, a month later than previously scheduled.
The Fed again pledged to keep a key bank lending rate near zero for "an extended period" to nurture an anticipated recovery.
Fed Chairman Ben Bernanke and his colleagues said the economy appeared to be "leveling out" -- a considerable upgrade from their last meeting in June, when the Fed observed only that the economy's contraction was slowing.
On Wall Street, stocks were mixed in morning trading Thursday. The Dow Jones industrial average dipped about 15 points, while broader indices edged up.
Initial claims reflect the pace of layoffs by employers. The Labor Department last week said companies cut 247,000 jobs in July, a large amount but still the smallest number in almost a year.
The unemployment rate dipped to 9.4 percent in July from 9.5 percent, its first drop in 15 months.
There were 617,000 new jobless claims in late June, before the figures were distorted last month by a shift in the timing of temporary auto plant shutdowns. That shift caused claims to drop sharply and then jump up last month.
Claims fell steeply last week, however, when the data were no longer affected by the distortions.
Still, initial claims remain far above the roughly 325,000 that economists say is consistent with a healthy economy. New claims last fell below 300,000 in early 2007.
Including federal emergency benefit programs, 9.25 million people received unemployment compensation in the week ending July 25, the latest data available. That's down from a record of 9.35 million the previous week. Congress has added up to 53 extra weeks of benefits on top of the 26 typically provided by the states.