Fed sees U.S. recession slowing; Europe morale up

By Nick Olivari and Dena Aubin

NEW YORK/LONDON (Reuters) - The U.S. economic contraction appears to be slowing, the Federal Reserve said on Wednesday, giving cheer to investors even as data showed the world's largest economy shrank sharply in the first quarter.

European data showed euro zone consumer and business morale picking up and investors also took heart from forecast-beating earnings to push up stocks and keep government bonds firm.

U.S. gross domestic product fell at a 6.1 percent rate in the first three months of the year, the Commerce Department said, much worse than the 4.9 percent contraction forecast by analysts in a Reuters poll.

Still, the report offered some glimmers of hope that the downturn could soon slow, with consumer spending up 2.2 percent and a sharp drawdown in inventories suggesting businesses' stock of unsold goods had been trimmed.

That may have helped the Fed to leave interest rates in the zero to 0.25 percent range they reached in December. No new policy actions to pump stimulus money into the U.S. economy were announced at the end of its two-day meeting on Wednesday.

"Overall, the Fed is not as pessimistic about the economic environment," said William Sullivan, chief economist at JVB Financial Group, Boca Raton, Florida.

"They emphasize that there are downside risks, but the statement is structured to emphasize that there are green shoots pointing to some potential improvement in the overall economic environment."

U.S. stocks .N were already higher after the GDP data suggested companies may start to rebuild inventories, which could help lift the economy out of recession. They extended gains after the Fed statement, with all three major indexes closing up more than 2 percent.