WASHINGTON - U.S. retail sales fell more than expected in August amid weak purchases of automobiles and a range of other goods, pointing to cooling domestic demand that further diminishes expectations of a Federal Reserve interest rate increase next week.

Other data on Thursday showed the labour market continuing to tighten with layoffs remaining very low last week, and underlying producer inflation creeping up in August.

Coming on the heels of reports showing a slump in manufacturing activity in August and a slowdown in job growth, the retail sales data could temper hopes of a strong rebound in economic growth in the third quarter.

"Continued momentum in household spending is an important component in the Federal Reserve's growth narrative and the softening in the third quarter is consistent with the theme of patience. A September hike is simply too soon," said Brittany Baumann, an economist at TD Securities in Toronto.

The Commerce Department said retail sales declined 0.3 per cent after edging up 0.1 per cent in July. Sales were up 1.9 per cent from a year ago. Excluding automobiles, gasoline, building materials and food services, retail sales slipped 0.1 per cent last month after a similar drop in July.

These so-called core retail sales correspond most closely with the consumer spending component of gross domestic product.

Economists had forecast overall retail sales slipping 0.1 per cent and core sales climbing 0.3 per cent last month.

The weak report could encourage the Fed to keep interest rates unchanged at its Sept. 20-21 policy meeting. Fed Governor Lael Brainard said on Monday she wanted to see stronger consumer spending data and signs of rising inflation before hiking rates.

The U.S. central bank raised its benchmark overnight interest rate at the end of last year for the first time in nearly a decade, but has held it steady since amid concerns over persistently low inflation.

Financial markets are pricing in only a 12 per cent probability of a rate hike next week, down from 15 per cent before the data, according to the CME FedWatch tool. The dollar was trading higher against a basket of currencies, while prices for U.S. government debt fell. U.S. stocks were marginally higher.

FIRMING INFLATION

The Fed could still raise interest rates as inflation pressures are gradually firming. A separate report from the Labour Department showed producer prices, excluding food, energy and trade services, increased 0.3 per cent in August after being unchanged in July.

The so-called core PPI increased 1.2 per cent in the 12 months through August, the biggest gain since December 2014. It increased 0.8 per cent in June.

The decline in retail sales last month was led by a 0.9 per cent fall in receipts at auto dealerships. Sales at service stations dropped 0.8 per cent. Households also cut back on discretionary spending, with sales at online retailers slipping 0.3 per cent and receipts at sporting goods and hobby stores decreasing 1.4 per cent.

There were also declines in sales at furniture and building material stores. Receipts at clothing stores, however, rose 0.7 per cent. Sales at electronics and appliance outlets gained 0.1 per cent and receipts at restaurants and bars rose 0.9 per cent.

Despite the drop in retail sales last month, consumer spending will likely remains supported by a strong labour market.

In a separate report, the Labour Department said initial claims for state unemployment benefits edged up 1,000 to a seasonally adjusted 260,000 for the week ended Sept. 10.

It was the 80th straight week that claims remained below the 300,000 threshold, which is associated with robust labour market conditions. That is the longest stretch since 1970, when the labour market was much smaller.

The tightening labour market is pushing up wages, with a government report on Tuesday showed a record increase in household income in 2015.

Robust consumer spending helped to blunt the blow on the economy from an inventory correction and prolonged drag from lower oil prices and a strong dollar, which restricted GDP growth to a 1.1 per cent annualized rate in the second quarter.

The Atlanta Fed is currently forecasting the economy growing at a 3.3 per cent rate in the third quarter.

Adding to the raft of weak August reports, data from the Fed showed manufacturing output fell 0.4 per cent in August, reversing July's increase.

Output was hurt by declines in the production of nondurable goods. While many durable goods industries posted declines of nearly 1 per cent or more, motor vehicle assembly increased.

There was good news from mining, where output rose 1.0 per cent. Oil and gas well drilling rose for a third straight month in August.