U.S. economy shrinks modestly

WASHINGTON Fri Jul 31, 2009 6:53pm EDT

1 of 3. A workman constructs a new home in Lemont, Illinois, July 27, 2009.

Credit: Reuters/John Gress

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WASHINGTON (Reuters) - The deepest U.S. recession since the Great Depression showed signs of easing in the second quarter, buttressing hopes for a second-half recovery, though it may be anemic as consumers are still strapped for cash.

Gross domestic product, which measures total goods and services output within U.S. borders, fell at a 1.0 percent annual rate in the second quarter, the Commerce Department said on Friday, after tumbling 6.4 percent in the January-March quarter, the biggest decline since early 1982.

Analysts who had expected a decline in second-quarter GDP of around 1.5 percent said the report, which showed a moderating pace of decline in key areas such as business investment and exports, provided the clearest evidence yet that the 19-month-old recession was almost over.

"The recession is entering its final hours. Today's report shows those green shoots are starting to grow again, and the economy is finally moving down the road to recovery," said Chris Rupkey, chief financial economist at Bank of Tokyo/Mitsubishi UFJ in New York.

It will be a recovery from a low point. The International Monetary Fund in its annual report on the U.S. economy said the recession seemed to be ending but cautioned recovery would be slow.

On a year-over-year basis, second quarter GDP declined a record 3.9 percent. Previously, the government said GDP had fallen at a 5.5 percent annual rate in the first quarter but it revised that to a steeper fall.

Including the second-quarter contraction, GDP has fallen for four straight quarters -- the first time that has happened since records were started in 1947.

A steep drop in consumption spending, the main engine of the economy, fanned fears of a sluggish growth pace assuming the economy does recover as anticipated in the second half.

Consumer spending, which accounts for over two-thirds of U.S. economic activity, fell at a 1.2 percent rate in the second quarter after rising 0.6 percent in the previous quarter. That sliced 0.88 percentage points from second quarter GDP, the department said.

"The increase in growth over the second half of 2009 is likely to be uneven, and the economy won't be firing on all cylinders again until three-quarters of GDP -- consumer expenditures and business capital spending -- start to pull their own weight," said Rupkey.

Investors set aside initial worries over the drop in consumer spending, lifting the Dow Jones industrial average stock index 17.15 points to 9,171.61. Sentiment was also lifted by a report showing business activity in the country's Midwest in July rose to its highest since September.

POSITIVE GDP GROWTH SEEN

President Barack Obama, whose poll numbers have been dropping because of concern about the costs of health-care reform and the ailing economy, said the GDP data was a sign the economy was headed in the right direction.

But he also said unemployment remained an obstacle.

"As far as I am concerned we won't have a recovery as long as we continue losing jobs. Today's GDP is an important sign the economy is headed in the right direction," Obama said.

In contrast to the weak consumer reading, business investment improved significantly in the second quarter.

The report showed business investment decreased at an 8.9 percent rate in the second quarter after diving 39.2 percent the previous quarter. Investment in nonresidential structures fell at an 8.9 percent rate compared to a 43.6 percent drop in the first quarter.

Residential investment, which is at the core of the downturn, dropped at a 29.3 percent rate in the April-June period after plummeting by 38.2 percent in the first quarter.

Business inventories continued to be a drag on overall GDP, declining by a record $141.1 billion in the second quarter as firms aggressively cut back on new production to reduce stockpiles of unsold goods.

The drop in inventories shaved 0.83 percentage point from second-quarter GDP, but was seen providing a springboard for the much-anticipated economic recovery in the second half.

"It really sets the stage for a positive third-quarter growth number and maybe now a pretty decent pop to the third quarter given the size of the inventory drawdown," said John Ryding, chief economist at RDQ Economics in New York.

Excluding inventories, GDP fell 0.2 percent in the second quarter compared to a 4.1 percent drop in the first quarter.

A free-fall in exports braked sharply in the second quarter. Exports fell at a 7.0 percent rate after plunging 29.9 percent in the first quarter. There were positive contributions from the federal, state and local governments during the quarter.

Annual benchmark revisions issued by the department showed the economy barely grew in 2008, expanding at an annual rate of 0.4 percent, the smallest since 1991, instead of the 1.1 percent previously estimated.

They also showed the decline since the recession began in 2007 was steeper than previously thought. From the fourth quarter of 2007 to the first quarter of 2009, real GDP fell at an average annual rate of 2.8 percent instead of a 1.8 percent decline.

(Additional reporting by David Lawder and Jeff Mason in Washington; Editing by James Dalgleish)

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