By Harriet Torry 

WASHINGTON -- A surge in retail sales and rising manufacturing output suggest the U.S. economy's strong growth in the second quarter continued into the third.

Retail sales -- a measure of spending at U.S. stores, websites and restaurants -- rose a seasonally adjusted 0.5% in July from the prior month, the Commerce Department said Wednesday. That was well ahead of economists' forecasts for a 0.1% increase.

Compared with a year earlier, they grew 6.4% in July. That's more than double the pace of inflation, which increased 2.9% in the year to July, as measured by the Labor Department's consumer-price index.

Robust hiring and low unemployment mean more households have income to spend. That is being amplified by tax cuts, which have resulted in less paycheck withholding and in elevated consumer confidence.

With demand strong, production is also up. U.S. factory output rose 0.3% in July, the Federal Reserve said Wednesday, and was up 2.8% from a year earlier, largely on higher auto and computer production.

The robust economic outlook is likely to keep Fed policy makers on track to raise short-term interest rates to a range between 2% and 2.25% when they meet next month, and move them higher again in December, to prevent the economy from overheating.

Growth in retail sales was driven by stronger spending at grocery stores, restaurants, department stores and clothing stores. Higher spending on nonessential discretionary items like restaurant meals suggests "households are not too worried about higher gas prices, and that tax cuts are providing a cushion," Morgan Stanley economists said in a note to clients.

Department-store chain Macy's Inc. on Wednesday raised its sales and earnings guidance for the fiscal year, citing in part the strong spending environment, although it reported a slight drop in net sales in the second quarter as it remodels stores.

"The consumer is healthy," Macy's Chief Executive Jeff Gennette said in an interview. "She is spending in our categories.

"We haven't seen signs that the consumer is running out of steam," he added.

Emily Assmus, a marketing coordinator from Virginia Beach, Va., said her family feels "pretty good" financially. She started a new job earlier this year and in July bought a new Chevrolet Suburban SUV to replace her 2008 vehicle.

"Most definitely I was able to not sweat having a larger car payment" because of the salary bump that came with her new position, the 37-year-old said.

Forecasting firm Macroeconomic Advisers estimates economic output will expand at a 3.2% rate in the third quarter, after 4.1% growth in the second. If the forecast holds up, it would represent the best back-to-back quarters for growth since the middle of 2014, and would be well above the trend of near 2% growth that has prevailed for most of this expansion.

Still, some indicators point to a potentially cloudier economic outlook. Rising interest rates and worker shortages could be squeezing the housing sector.

The National Association of Home Builders said Wednesday its index that measures confidence in the market for new single-family homes fell to 67 in August from 68 in July. While the NAHB said demand for new housing remains strong, builders reported affordability concerns amid rising construction costs, shortages of skilled labor and low supply of land to build on.

--Suzanne Kapner contributed to this article.

Write to Harriet Torry at harriet.torry@wsj.com

(END) Dow Jones Newswires

August 15, 2018 14:34 ET (18:34 GMT)

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