U.S. economy tumbles steeply in first quarter

By Lucia Mutikani

WASHINGTON (Reuters) - The U.S. economy shrank by a surprisingly steep 6.1 percent in the first quarter, hit by a record plunge in business inventories and sinking exports, but investors read signs of recovery in the report.

The economy remained on track to emerge from recession in the second half of the year, analysts said, pointing to the run down in inventories that helped boost U.S. stock prices.

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 on Wednesday 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 at an annual rate of 6.1 percent, which followed a fourth-quarter decline of 6.3 percent, was much steeper than economists had expected, investors were cheered as they saw it laying the groundwork for a recovery.

THE FED'S ENCOURAGING WORDS

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. The Dow Jones industrial average jumped 168.78 points, or 2.1 percent, to 8,185.73, the highest closing level since February. Government bond prices sank while their yields, which move inversely to prices, jumped to 5-month highs. The 10-year note's yield shot up to 3.09 percent.

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.

SILVER LINING IN GRIM DATA

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.