Retail Sales Suffer Biggest Drop In More Than A Year As Iran War Casts Shadow Over Economy

Americans sharply pulled back on retail spending in July even as inflation remained elevated, raising fresh questions about whether the U.S. economy is weakening beneath the surface of the Iran war’s supply-driven price shock.

Retail sales fell 0.6% in July from the previous month, the Commerce Department reported Friday, marking the largest monthly decline since May 2025 and missing economists’ expectations for a modest increase. The Federal Reserve has acknowledged that the conflict in the Middle East has produced supply shocks, particularly in energy, contributing to elevated inflation.

The central bank has simultaneously warned that household consumption has been growing only modestly.

For American households, the problem is more straightforward: they are facing higher prices at the same time that the economy is showing signs of weakening demand. The result is less purchasing power and fewer opportunities to absorb another round of higher costs.

The headline figure is nominal, meaning it is not adjusted for inflation. Consumer prices increased another 0.1% in July, according to government data, meaning the underlying volume of goods being purchased fell by more than the headline retail figure suggests. A rough adjustment for consumer-price growth would put the July decline in real terms at around 0.7%, though the precise figure depends on the deflator used for retail sales.

At the same time, Americans are becoming less confident about the economy. The University of Michigan’s preliminary consumer-sentiment reading fell to 51 in August, down from 55.2 in July and ending a two-month improvement. The deterioration was particularly pronounced among older and lower-income consumers and Americans without college degrees.

Taken together, the data suggests the American consumer — the engine behind roughly two-thirds of economic activity — are pulling back from spending.

Nominal retail sales were still 5% higher in July than they were a year earlier, but that figure also reflects the higher prices Americans are paying.

The labor market is providing another warning sign. Employers shed 23,000 jobs in July, while the labor-force participation rate slipped to 61.4%. The unemployment rate was relatively low at 4.1% in part because more people left the workforce, and wage growth slowed to 3.2% annually.

Inflation associated with the Iran conflict could obscure a deterioration in the underlying economy. A temporary increase in energy prices can push measured inflation higher even as households cut back on discretionary purchases, businesses confront weaker demand and real economic activity slows.

The Fed’s July monetary policy report said inflation had risen further this year in part because of supply shocks, including higher energy costs related to the Middle East conflict. At the same time, the Fed said household consumption had increased only “very modestly” in the first quarter.