WASHINGTON (Reuters) –
The U.S. economy contracted at a surprisingly steep 6.1 percent rate in the first quarter, dragged down by a record plunge in business inventories and a slump in exports, data showed on Wednesday.

However, the data did not change views the economy would emerge from recession in the second half of the year. The recession is in its 16th month and next month is on track to become the longest since the Great Depression.

The Commerce Department said inventories were drawn down by a record $103.7 billion -- potentially good news for the economy because it suggests businesses have cut their stockpiles of merchandise to levels that will let them start placing new orders, stimulating production.

"The larger-than-expected decline in first-quarter GDP is good news for the upcoming quarters. We expect that the recession will be over in the second half of the year," said Harm Bandholz, an economist at Unicredit Markets and Investment Banking in New York.

While the drop in gross domestic product, which followed a 6.3 percent fourth-quarter decline, was much steeper than economists had expected, investors were cheered as they saw it laying the groundwork for a recovery.

The Federal Reserve, in a statement following a regular two-day meeting, said the pace of deterioration in the economy appeared to be slowing and that the U.S. central bank would continue to keep interest rates exceptionally low for an extended period.

U.S. stocks rallied, further helped by unexpectedly strong earnings from Time Warner Inc and Qwest Communications International, with the S&P 500 index breaching the key 875 technical resistance level and posting a three-month intraday high. Government bond prices fell sharply.

GDP, which measures total goods and services produced within U.S. borders, has now dropped for three straight quarters for the first time since the 1974-1975 recession. That downturn, which started in 1973, lasted 16 months.

The Fed, which left its benchmark overnight lending rate in the zero to 0.25 percent range on Wednesday, has pumped about a trillion dollars into the market to help credit markets and break the economy's downward spiral.


Christina Romer, the head of the White House Council of Economic Advisers, told Reuters Financial Television the decline in inventories and a rise in consumer spending offered a silver lining in an otherwise bleak report.

"To the degree that's a sign that firms are bringing down some of their inventories ... that combined with consumers coming back to life could mean we need to start producing things again," she said. "It could put us in a position for perhaps a less dreary number going forward."

The inventory plunge accounted for 2.79 percentage points of the drop in GDP. Excluding inventories, GDP contracted 3.4 percent.

Business investment, which is typically made when companies are planning production increases, tumbled a record 37.9 percent in the first quarter.

However, consumer spending, which accounts for over two-thirds of U.S. economic activity, rose 2.2 percent after collapsing in the second half of 2008. Consumer spending was bolstered by a 9.4 percent jump in purchases of durable goods, the first advance after four quarters of decline.

"We can expect some moderation in the pace of the economy's decline. The larger question now surrounds the intense weakness we have seen in business investment," said Bob DiClemente, chief economist at Citigroup in New York.

"It's going to draw much attention as a potential source of aggravating factor for the recession going forward."


Home-building activity slid at a 38 percent rate, the biggest decline since the second quarter of 1980. There are signs, however, that a big drop in construction activity is starting to slow and analysts expect this component to begin showing improvement in the quarters ahead.

Exports collapsed 30 percent, the biggest decline since 1969, after dropping 23.6 percent in the fourth quarter as recession took hold around the globe. The decline in exports knocked off a record 4.06 percentage points from GDP.

The Commerce Department said a $787 billion government package of spending and tax cuts, approved in February, had little impact on first-quarter GDP. Part of the stimulus package is designed to bolster state and local government spending, which fell at a 3.9 percent rate in the first quarter, the largest drop since 1981's second quarter.

A separate report showed U.S. home loan applications fell 18.1 percent last week to the lowest level since mid-March, even as mortgage rates clung to record lows.

(Additional reporting by Tim Ahmann in Washington and Lynn Adler in New York; Editing by Chizu Nomiyama)