The fall last month followed a 1.4 per cent rise in June, taking the year-on-year growth rate to 2.2 per cent, said the Office for National Statistics.
A Treasury spokesman welcomed the figures and claimed sales were "on an upward trend". But many City economists, who had been expecting a small rise, were surprised by the dip.
They added that the figures would strengthen arguments by the Chancellor, Kenneth Clarke, for a further cut in base rates in the run-up to the general election next year.
Jonathan Loynes, UK economist at HSBC Greenwell, said: "The figures will help to ease fears of a return to a 1980s-style consumer boom and will provide useful ammunition for Mr Clarke."
The Office of National Statistics' data showed British shoppers were feeling the benefit of cheaper mortgages costs, tax cuts and rising incomes after years of tough pay restraint.
High spending on expensive household items in particular, up 3.8 per cent in the year to July, suggested consumers are feeling more confident about the future, largely thanks to higher real incomes as tax and interest rate cuts hit home. Spending on household items was fuelled by the recovery in the housing market.
However, other analysts said a rate cut based on one month's fall in shop sales would be a risky strategy and the Chancellor might then come under pressure for a politically unpopular rate rise before the general election.
Alex Garrard, UK economist at UBS, the Swiss banking group, said: "We are inclined to view the monthly drop in retail sales as an aberration.
"[It] reflects a rebound from the extraordinarily high level of retail activity in June, which was somewhat artificially boosted by a weather- related jump in clothing and footwear sales and spending of overseas visitors [over] here to watch the Euro 96 Football Championships."
One economist suggested that if the Chancellor were to insist on another rate cut, there would be another clash with Eddie George, Governor of the Bank of England, who is implacably opposed to a reduction.
The two men disagreed in June when rates were cut by 0.25 of a percentage point to 5.75 per cent, with the Bank of England warning that strong consumer spending might mean inflation picking up next year.
Despite hopes of further interest cuts helping share prices, the FT- SE 100 index fell back 11 points from its record high the day before, to 3,872.1 by close of trade yesterday.Reuse content