U.S. economy contracts mildly in Q1, but growth rebounding

By Lucia Mutikani

WASHINGTON (Reuters) - The U.S. economy contracted in the first quarter but less than previously estimated as it struggled with bad weather, a strong dollar, spending cuts in the energy sector and disruptions at West Coast ports.

Growth, however, has since rebounded in the second quarter as the temporary drag from unusually heavy snowfalls and the ports dispute faded. Retailers reported strong sales in May and employers stepped up hiring. Housing is also strengthening and manufacturing activity is beginning to stabilize.

A steadily firming economy could encourage the Federal Reserve to raise interest rates later this year.

The Commerce Department said on Wednesday gross domestic product shrank at a 0.2 percent annual rate in the January-March quarter instead of the 0.7 percent pace of contraction it reported last month.

A fairly stronger pace of consumer spending and inventory accumulation than previously estimated accounted for the upward revision to GDP. Business investment spending was less weak than the government had estimated last month.

"These revisions have a marginally positive impact on our view of the second quarter. Demand is still solid, but the adjustment to the strong dollar has not run its course," said Nariman Behravesh, chief economist at IHS in Lexington, Massachusetts.

Consumer spending, which accounts for more than two thirds of U.S. economic activity, was raised to a 2.1 percent growth pace from the 1.8 percent rate reported in May.

With more Americans getting a paycheck and a tightening labor market finally spurring stronger wage growth, consumer spending could accelerate in the second quarter.

Spending could also get a boost from rising household wealth as home prices accelerate. Personal savings increased at a robust $720.2 billion pace in the first quarter.

Though export growth was revised higher, that was offset by an upward revision to imports, leaving a still-large trade deficit that subtracted almost 2 percentage points from GDP.

U.S. stocks were trading slightly lower as debt negotiations between Greece and its foreign creditors hit a snag. The dollar was little changed against a basket of currencies, while prices for longer-dated U.S. Treasury debt rose.

UNDERLYING STRENGTH

The economy was initially reported to have grown at a 0.2 percent rate at the start of the year. It expanded at a 2.2 percent rate in the fourth quarter.

Growth estimates for the second quarter are currently between a 2.0 percent and 3.0 percent rate.

But the first-quarter slump in output likely is not a true reflection of the economy's health. Economists, including those at the San Francisco Federal Reserve Bank, say a problem with the model the government uses to smooth the data for seasonal fluctuations also contributed to depressing the GDP number.

The government said last month it was aware of the potential problem and was working to address it when it publishes annual GDP revisions in July.

"We do not believe that economic activity stalled in the first quarter. Other data on labor markets ... are more consistent with a modest pace of economic activity," said Michael Gapen, chief economist at Barclays in New York.

Over the past year, GDP expanded 2.9 percent. When measured from the income side, the economy expanded at a 1.9 percent rate in the first quarter instead of the previously reported 1.4 percent pace. A measure of domestic demand growth was revised up four-tenths of a percentage point to a 1.2 percent rate.

Economists estimate unusually heavy snowfalls in February sliced off at least one percentage point from growth.

Dollar strength and lower energy prices have been a drag on business spending and factories, with manufacturing production also undercut by the ports labor dispute.

Businesses accumulated $4.5 billion more in inventory than previously estimated in the first quarter, which could mean they have little incentive to keep on adding to stock in the current quarter. Inventories contributed 0.45 percentage point to GDP instead of the previously reported 0.33 percentage point.

Inventories could be a drag on second-quarter GDP.

The buoyant dollar also weighed on after-tax corporate profits, which were a bit weaker in the first quarter than previously thought. Profits after tax were revised to show a 8.8 percent drop instead of the 8.7 percent fall reported in May.

For graphics on:

U.S. GDP, click on http://graphics.thomsonreuters.com/15/GDP-contrib/index.html

U.S. mortgages, click on http://link.reuters.com/guv37s

(Reporting by Lucia Mutikani; Editing by Andrea Ricci)