The U.S. economy shrank less than expected in the second quarter, despite a record drop in inventories, and fewer workers filed new claims for jobless benefits last week, a sign the economy was starting to heal.

Gross domestic product fell at a 1.0 percent annual rate, unchanged from an estimate last month, the Commerce Department said on Thursday. Economists had expected a steeper 1.5 percent drop after a 6.4 percent collapse in the first quarter.

A separate report from the Labor Department showed the number of U.S. workers filing new claims for jobless benefits fell by 10,000 to 570,000 last week, suggesting some easing in the pace of layoffs.

While the revisions to real GDP were small, they generally reinforce the view that economic activity will snap back in the current quarter, said Mark Vitner, a senior economist at Wells Fargo Securities in Charlotte, North Carolina.

The U.S. economy appears to be emerging from its longest and deepest recession since the Great Depression. Despite the fairly positive data on Tuesday, U.S. stocks fell, dragged down by shares of technology and energy companies <.N>. U.S. government bond prices were lower.

The GDP report showed businesses were more aggressive in reducing inventories than previously thought.

Business inventories dropped a record $159.2 billion in the second quarter, instead of the $141.1 billion estimated last month. Stripping out inventories, GDP rose 0.4 percent -- the first gain since the second quarter of 2008.

Analysts said the sharp drawdown in inventories in the face of weak demand had likely run its course, and that the lean level of stocks would provide a springboard for an economic recovery many believe is already under way.


The economy should enjoy something of a rebound over the next couple of quarters, as inventories are restocked and pent-up demand is released, said Paul Ashworth, a senior U.S. economist at Capital Economics in Toronto.

Richmond Federal Reserve Bank President Jeffrey Lacker on Thursday said the economy appears to have leveled out and ... we can look forward to better times ahead.

The blow from the sharp inventory decline was softened by a smaller-than-initially estimated drop in consumer spending, which accounts for about 70 percent of U.S. economic activity.

Consumer spending fell at a 1.0 percent rate in the second quarter. A month ago the department estimated that it had drop a somewhat steeper 1.2 percent.

With unemployment high and rising, there are fears weak consumer spending will restrain the recovery's momentum.

Wage and salary disbursements fell $235.7 billion in the first quarter, $31.1 billion more than previously thought.

With consumers still crippled by credit restrictions, a legacy of high debts and high unemployment, that (growth) rebound will take much longer to develop into a truly sustainable recovery, said Capital Economics' Ashworth.

Drops in exports and homebuilding that were not as steep as previously estimated also helped minimize the decline in GDP.

Doubts over the strength of the recovery have left companies reluctant to start hiring new workers, though the pace of layoffs has slowed significantly.

The number of workers still on the jobless benefits rolls after claiming an initial week of aid fell to 6.13 million in the week ended August 15 from 6.25 million in the prior week, the Labor Department said. It was the lowest level of so-called continued claims since the week ending April 4.

There are some signs of stability in the labor market. The big drop on the inventory suggests that the inventory burn is finished so production is going to stabilize. You are basically in a situation where the labor market is bottoming out, said Nick Kalivas, vice president of financial research at MF Global in Chicago.

The GDP report showed after-tax corporate profits rose 2.9 percent in the second quarter, reflecting aggressive cost cutting by businesses, after gaining 1.3 percent in the first three months of the year.

(Additional reporting by Lisa Lambert and Mark Felsenthal)