(Corrects figures in 14th and 15th paragraphs to reflect inflation-adjusted data.)

July 31 (Bloomberg) -- The U.S. economy shrank at a slower pace in the second quarter, a sign that the worst recession since the Great Depression may be winding down.

Gross domestic product contracted at a less-than-projected 1 percent annual rate after shrinking 6.4 percent in the prior three months, the most in 27 years, Commerce Department figures showed today in Washington. Revisions showed the economic downturn last year was even deeper than previously estimated.

Profits at companies from Caterpillar Inc. to Dow Chemical Co. signal the slump is abating as government efforts to revive lending and President Barack Obama’s stimulus gain traction. At the same time, today’s report showed that consumer spending, which accounts for 70 percent of the economy, shrank more than twice as much as forecast last quarter; analysts anticipate it will take months to recover as job losses mount.

“We’re well on our way to a recovery but, inevitably, it’ll be choppy,” Joseph LaVorgna, chief U.S. economist at U.S. Deutsche Bank Securities in New York, said before the report. “The consumer is taking a back seat as we still have major job losses. The labor market really needs to show a lot of improvement.”

Treasuries headed higher after the report, while stock- index futures fluctuated between gains and losses. Benchmark 10- year note yields were at 3.59 percent at 8:36 a.m. in New York, from 3.61 percent late yesterday. Contracts on the Standard & Poor’s 500 Stock Index were down 0.1 percent at 981.

Economists’ Forecasts

The economy was forecast to shrink at a 1.5 percent pace, according to the median estimate of 78 economists surveyed by Bloomberg News. Estimates ranged from a 0.7 percent gain to a decline of 2.9 percent.

GDP was down 3.9 percent from the second quarter in 2008, the biggest drop since quarterly records began in 1947. Last quarter’s decline was the fourth in a row, also the longest losing streak on record.

Benchmark revisions showed the world’s largest economy contracted 1.9 percent from the fourth quarter of 2007 to the last three months of 2008, compared with the 0.8 percent drop previously on the books.

The GDP report is the first for the quarter and will be revised in August and September as more information becomes available.

Spending Contraction

Consumer spending, which accounts for more than two-thirds of the economy, fell at a 1.2 percent pace, more than forecast, following a 0.6 percent increase in the prior quarter. Purchases were forecast to drop 0.5 percent, according to the survey median.

The economy has lost 6.5 million jobs since the recession began in December 2007, and economists surveyed by Bloomberg this month forecast the jobless rate will exceed 10 percent by early 2010.

“The United States economy has found bottom but will be slow in recovering as unemployment continues to be a drag on consumer spending,” Andrew Liveris, chief executive officer of Midland, Michigan-based Dow, said in a statement yesterday.

Second-quarter profit at Dow and at Peoria, Illinois-based Caterpillar, topped analysts’ estimates. Caterpillar, the world’s largest maker of construction equipment, said last week that stimulus programs in countries such as China were helping stabilize sales.

Trade Deficit

The trade gap shrank last quarter, preventing a steeper decline. The gap between exports and imports fell to $339.3 billion at an annual pace from $386.5 billion.

Inventories dropped at a record $141.1 billion annual pace, after a $113.9 billion decline.

Leaner stockpiles set the stage for recovery in production.

“With inventory levels in an ultra-lean state, businesses should start adding inventories in the second half of the year as the economy begins to show signs of life,” said Ellen Zentner, senior economist at Bank of Tokyo-Mitsubishi UFJ Ltd.

General Motors Co. and Chrysler Group LLC, both out of bankruptcy, are among firms set to ramp up production as government efforts lift demand.

The “cash-for-clunkers” trade-in program begun this month has spurred 16,351 new-vehicle sales so far, the Transportation Department said on July 29. The plan, which set aside $1 billion, ran through the money six days after it began, a sign of its success, Senator Debbie Stabenow said yesterday. Lawmakers had expected the program to generate about 250,000 vehicle sales and to have enough money to last to about Nov. 1.

Business Investment

Today’s GDP report showed the slump in business investment slowed last quarter, while residential construction kept plummeting.

Recent reports showed the housing slump, which helped trigger the financial crisis last year, and the decline in manufacturing have eased. Housing starts rose in June and industrial production shrank at the slowest pace in eight months, according to government reports this month.

The Federal Reserve’s preferred inflation gauge, climbed at a 2 percent annual pace last quarter, less than forecast. The measure, which is tied to consumer spending and strips out food and energy costs, rose at a 1.1 percent annual pace the prior quarter.

Economists project the economy will grow at an average 1.5 percent pace from July to December, according to a Bloomberg survey taken in early July.

The Standard & Poor’s 500 Index and Dow Jones Industrial Average are up 12 percent since July 10 on better-than- anticipated earnings at companies from Motorola Inc. to 3M Co.

The country “may be seeing the beginning of the end of the recession,” Obama said this week. Even so, “we know the tough times aren’t over.”

To contact the reporter on this story: Shobhana Chandra in Washington at schandra1@bloomberg.net

Last Updated: July 31, 2009 09:14 EDT