July 27 (Bloomberg) -- Japan's retail sales unexpectedly dropped in June, as higher taxes, lower wages and a furor over lost pension records weighed on consumer sentiment.

Sales fell 0.4 percent from a year earlier, the Trade Ministry said today in Tokyo. The median estimate of 25 economists surveyed by Bloomberg News was for a 0.6 percent gain.

``We see a risk of a mild slowdown in retail sales in the short run,'' said Takehiro Sato, chief economist for Japan at Morgan Stanley in Tokyo, citing an increase in local residents' taxes and the abolition of temporary tax cuts.

A recovery in household spending may be cut short after five months of gains, hampering growth in the world's second- largest economy. Consumers became the most pessimistic in more than two years in June as taxes rose, wages fell and a government agency said its mishandling of pension records could result in billions of yen in unpaid benefits.

The decline was led by falling sales of automobiles, household appliances and beverages, the ministry said. From a month earlier, retail sales slumped 0.8 percent.

Consumer prices excluding fresh food fell 0.1 percent in June from a year earlier, a fifth monthly drop, the statistics bureau said today. The decline matched economists' predictions.

The yen traded at 118.81 per dollar at 9:07 a.m. in Tokyo compared with 118.59 before the reports were published.

Economy Watchers

The Economy Watchers index, a gauge of the strength of domestic demand via a survey of people who deal directly with consumers, fell to the lowest level in two years in June.

``Consumer spending is recovering overall, but sentiment remains weak,'' Economic and Fiscal Policy Minister Hiroko Ota said on July 17. ``We need to examine consumer sentiment to establish the reasons for its weakness.''

Sales by large retailers rose 0.9 percent in June, the ministry said. Department store sales surged 5.5 percent, the fastest pace in nine years, after stores brought forward the start of summer discounts to take advantage of an extra Saturday in June, the Department Stores Association said last week.

Today's report only accounts for spending in shops. It excludes Internet retailing and outlays on services provided by gyms, restaurants and movie theaters. Spending on travel, for example, rose at 10 times the pace of retail sales last year, according to the Japan Association of Travel Agents.

``It becomes increasingly difficult to gauge actual consumption through these statistics, as consumers' purchasing venues have diversified,'' Morgan Stanley's Sato said.

To contact the reporter on this story: Toru Fujioka in Tokyo at tfujioka1@bloomberg.net

Last Updated: July 26, 2007 20:08 EDT