The drop was even bigger after auto sales were excluded, falling 0.6 per cent compared with June.
Economists had expected an overall gain of 0.5 per cent and flat results excluding auto sales, according to Thomson Reuters.
"Though auto-related spending continued its momentum, Canadians aren't using their new cars to drive to the shopping mall," CIBC economist Nick Exarhos wrote in a note to clients.
"We've noted how a tapped out consumer would run out of gas after having dropped savings dramatically over the past several quarters, and July’s retail data may be a first sign post of that."
The weaker than expected retail sales report for July follows data last week that found wholesale sales fell 0.3 per cent in the same month. Economists had expected them to rise.
David Madani of Capital Economics said the combination of lower retail and wholesale sales suggested that the economic recovery lost some momentum at the start of the third quarter.
"Our calculations indicate that retail sales have fully recovered from the weakness over the winter and spring seasons," Madani wrote in a report.
"With record high household debt and challenging labour market conditions likely to persist, we anticipate only modest growth in retail sales in the months ahead."
Statistics Canada said retail sales declined in five of 11 subsectors, representing 55 per cent of retail trade.
Sales at general merchandise stores decreased 2.7 per cent, while sales at supermarkets and grocery stores were down 1.1 per cent.
Motor vehicle and parts dealers saw sales grow by 1.6 per cent, the third increases in four months.
Retail sales were down in four provinces in July, with lower sales in Quebec and, to a lesser extent, British Columbia, accounting for most of the decrease.