* Rising prices and falling sales underscore tough economic climate
* August data slightly better than expected, lifts sterling
* Economists warn that retail outlook is bleak, consumers squeezed
(Adds comment, detail, market reaction, Bank of England inflation survey)
By Peter Griffiths and Fiona Shaikh
LONDON, Sept 15 British retail sales fell in August and prices rose at their fastest annual rate in three years, in a further sign of the pressures consumers face from high inflation, low wage growth and worries about the UK's sluggish economic recovery.
While the numbers were modestly better than expected, economists said the outlook for stores was bleak and that a run of gloomy data would raise pressure on the Bank of England to start a second round of asset purchases to boost growth.
Consumer confidence is weak at a time of tight household finances, rising unemployment and fears that the euro zone debt crisis and slowing global growth could tip Britain back into recession.
The Office for National Statistics said sales volumes including automotive fuel dropped by 0.2 percent, slightly better than forecasts for a dip of 0.3 percent. Sales volumes did not grow at all on the year -- the weakest since December 2010.
Underlying sales in the three months to August rose 0.3 percent, and have been virtually flat for most of the last year. Britons have suffered the biggest drop in incomes in 30 years as the economy struggles to recover from its deepest downturn in decades, forcing consumers to cut spending.
Sterling rose to a session high against the dollar and UK gilt futures extended losses after the figures were released. [ID:nL5E7KF0PS]
"The big picture view here is that the consumer will remain under pressure for a prolonged period of time," said Amit Kara, economist at UBS.
Retail prices were 4.7 percent higher than a year ago, the highest rate of retail price inflation since July 2008. The acceleration reflected the biggest annual jump in clothing and footwear prices since 1991.
Rising inflation and the threat of job cuts as a result of hefty public spending cuts have depressed consumer morale to its weakest since Britain was in the depths of recession.
Data on Wednesday showed British unemployment rose at its fastest pace in two years in the three months to July, fuelled by record public sector job losses. [ID:nL3E7KE23P]
"It is inflation that is killing the growth numbers," said RBS economist Ross Walker. "I don't think you are going to see a recovery in volumes and therefore real household consumption growth until inflation is back down."
Britons' inflation expectations for the next year rose to their highest level in three years, a separate Bank of England survey showed on Thursday. The BoE's August inflation attitudes survey said average public inflation expectations for the next 12 months rose to 4.2 percent compared to 3.9 percent in the May poll. [ID:nAHLEKE73G]
The effect of rioting in several English cities in August was hard to quantify, the ONS said.
Some shops did lose money because they had to close early during four days of looting and violence. However, other retailers said they had picked up trade as people changed where and when they went shopping.
British retailer John Lewis [JLP.UL] - seen as a barometer for UK retailing - reported an 18 percent drop in first-half profits on Wednesday, due to discounting and higher investment. [ID :nL5E7KE090]
Discount retailer Primark (ABF.L) said this week it had taken a hit from the summer sales starting early and from having to cut prices more than previously. Household goods retailer Argos (HOME.L) said sales in its second quarter dropped almost 9 percent as Britons shied away from buying consumer electronics.
(Reporting by Peter Griffiths; Editing by Catherine Evans)
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