Economists had expected that lower prices for gas might entice shoppers to spend more.
Instead, the Commerce Department reported that retail sales dipped 0.3 percent in August.
The August slump followed an even bigger 0.5 percent decline in July, the weakest performance in five months and much worse than the 0.1 percent decline originally reported.
The back-to-back drops in retail spending increased concerns that the economy, which has gotten a boost from $93.4 billion in stimulus payments could falter in coming months now that the mass distribution of checks has come to an end.
The economy grew at a surprisingly strong 3.3 percent rate in the April-June quarter. Economists believe the increase in the gross domestic product could slow to a barely discernible 1 percent rate in the current July-September period. And GDP actually may turn negative in the final three months of this year and the first quarter of next year, they think, meeting the classic definition of a recession.
"There are a long list of negatives confronting consumers at the moment from falling employment to falling home and stock prices," said Nigel Gault, chief U.S. economist for Global Insight.
The preliminary reading for consumer sentiment in the University of Michigan/Reuters survey released Friday did show a rebound to 73.1, the best showing since January and up from 63.0 in August.
But Gault said that most of that rebound reflected the decline in gasoline prices that has occurred in recent weeks, reducing worries about inflation. Consumers' spending expectations for big-ticket items remained depressed, according to the survey.
"There are too many negatives facing the consumer to expect an early turnaround in consumer spending," said Gault, who is one of the economists forecasting negative GDP readings in the coming two quarters.
Democrats in Congress including Sen. Barack Obama, the party's presidential nominee, have called for a second stimulus package.
Prospects appear dim given the opposition of the Bush administration, which is concerned that further stimulus will make a grim deficit outlook even worse.
The administration is projecting that the deficit for the next president's first year in office will soar to an all-time high of $482 billion, a forecast that does not include the costs of the government takeover last Sunday of mortgage giants Fannie Mae and Freddie Mac.
But many economists are worried that consumer spending, which accounts for two-thirds of total economic output, will likely turn negative in the current quarter, something that has not happened in 17 years.
"Whenever they can, consumers are postponing purchases including appliances, building materials and furniture," said Sung Won Sohn, an economics professor at the Martin Smith School of Business at California State University, Channel Islands.
While auto sales were strong in August, reflecting a rebound from July, sales at all other merchants fell by 0.7 percent. Sales declined at electronics and appliance stores, clothing shops, building and garden stores and department stores.
The 0.9 percent decline in producer prices, which measure cost pressures before they get to the consumer, was the biggest one-month drop since October 2006 and should be welcome news at the Federal Reserve.
Core inflation, which excludes energy and food, was also well-behaved, edging up just 0.2 percent in August, in line with expectations and well below the 0.7 percent spike of the previous month.
The Fed has been worried that it might have to start raising interest rates if inflation pressures did not start to moderate. Fed officials are expected to keep rates unchanged when they meet next Tuesday. With inflation retreating, they will likely hold rates steady for the rest of this year.
The government will release its look at consumer prices in August next Tuesday and economists were forecasting a decline of around 0.1 percent, a significant improvement from the 0.8 percent surge turned in during July.
That improvement is expected to be heavily influenced by the drop in gasoline prices that has occurred in recent weeks. Since spiking to a record at $4.11 per gallon in mid-July, pump prices are now around $3.68 nationwide, reflecting a fall in crude oil prices from a record of $147 per barrel to around $100 per barrel.
There is a threat, however, that gasoline prices may spike upward again at least temporarily if Hurricane Ike disrupts refinery operations along the Gulf Coast for an extended period.
For August, gasoline prices at the wholesale level fell by 3.5 percent, while the price of natural gas and home heating oil also declined.
Food costs edged up 0.3 percent in August, matching the July gain. A big 13.2 percent plunge in the price of fresh vegetables was offset by increases in the cost of pork, eggs and processed fruit and vegetables.
The 0.2 percent rise in prices excluding food and energy left core inflation rising by 3.6 percent over the past 12 months, the highest since a 3.7 percent increase for the 12 months ending in May. All wholesale prices were up 9.6 percent over the past 12 months, the second-highest reading in the past 27 years, reflecting the pressures from surging energy costs.
