Published: Tuesday, 3 Nov 2009 | 11:32 PM ET

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Australian retail sales fell unexpectedly in September to set the seal on a soft third quarter - payback for fiscal-driven strength earlier in the year, which  adds to doubts about the need for a near-term rate rise.

The Australian dollar slipped a third of a U.S. cent while interest rate futures edged up as investors rowed back on bets the Reserve Bank of Australia would raise rates in December.

"The sales figures are certainly an indication of policy fade coming through," said Michael Blythe, chief economist at Commonwealth Bank. "These numbers won't stop future rate rises but the odds on a move in December are starting to lengthen."

The central bank, the RBA, lifted its cash rate by 25 basis points to 3.5 percent on Tuesday, the second hike in as many months, as it steadily withdrew stimulus from a surprisingly
strong economy.

Up until then, the market had been fully priced for a move to 3.75 percent in December, but the RBA's commitment to tightening only gradually threw that into doubt.

By Wednesday, interbank futures were implying a one-month rate of 3.63 percent for December, while a measure from Credit Suisse showed a 50-50 chance of a hike.

The government's retail numbers showed a 0.2 percent drop in sales for September, confounding analysts' forecasts for a 0.4 percent rise, as shoppers spent less on household goods, clothing and at department stores.

That left sales down 0.4 percent for the third quarter as a whole at A$56.96 billion ($51.5 billion) in inflation-adjusted terms. That was the first quarterly drop in a year and in large part reflects a natural pullback from fiscal-induced spending.

A Drag on GDP    

The Labor government handed out billions in payments in  December and April to support the economy during the depths of the global credit crisis. Grants to businesses to buy vehicles
also brought spending forward into the first half of the year.

"Retail sales volumes in Q3 point to a 0.1 percentage point detraction from growth which, together with a likely detraction from net exports, hint at a flat, possibly negative, quarter for
GDP," noted Su-Lin Ong, a senior economist at RBC.

Gross domestic product figures are due for release on December 2, the day after the RBA's next policy meeting, so even the chance of a negative reading could make the central bank
think twice about raising rates then.

Yet, Ong also noted the RBA had fully expected consumer demand to fade somewhat once the fiscal boost had passed.

And other data on the services sector out on Wednesday suggested October might have been a better month.

The Australian Industry Group (AiG)-Commonwealth Bank performance of services index (PSI) climbed 5.5 points in October to 54.8, signalling expanding activity for the first time in 19
months.

Crucially, the survey of around 200 companies found a notable recovery in the retail sector, supporting the RBA's optimism that consumer demand would hold up.

That is important as retail sales account for about 23 percent of Australia's GDP and the industry is the biggest employer with about 15 percent of all jobs.

There was also favourable news on housing with approvals to build new homes rising 2.7 percent in September, putting them 11.7 percent up on the same month last year.

"Overall, we still think there's a decent chance they will hike in December and I'm not sure that these numbers are that much of a surprise," argued RBC's Ong.

Whether or not they move in December, the market still sees rates reaching around 4.5 percent by June and ending next year above 5.0 percent.

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