* U.S. economy shrinks more severely than forecast in Q1
* Inventories plummet by record amount, exports collapse
* Consumer spending recovers after sharp declines (Recasts, updates markets)
By Lucia Mutikani
WASHINGTON, April 29 (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 the recession, now in its 16th month, in the second half of the year. Next month, the downturn 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 the stockpile of unsold merchandise to levels that will let them start placing new orders, which would stimulate 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.
U.S. stocks rose, further helped by unexpectedly strong earnings from Time Warner Inc TWX.N and Qwest Communications International Q.N, with the blue-chip Dow Jones industrial average .DJI up about 143 points at midday.
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 data came as the Federal Reserve resumed a two-day meeting. The Fed, which has cut interest rates to almost zero and pumped about a trillion dollars into the economy to try to break its downward spiral, is expected to nod to signs hinting at economic improvement in a post-meeting statement.
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 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. [ID:nN29409284] (Additional reporting by Tim Ahmann in Washington and Lynn Adler in New York; Editing by Jan Paschal)