Sales at U.S. retailers sank in July for the first time in three months despite the government's popular 'cash for clunkers' incentive program, indicating that the American economy faces a bumpy recovery from its worst recession since World War II.

The Federal Reserve announced Wednesday that it will keep short-term interest rates at a record low in order to further stabilize the U.S. economy. But it signaled confidence in the recovery, saying economic activity is "leveling out."…