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Economy shrank during first quarter, government data show

Despite the first quarter contraction, many believe the economy is already picking up. (Photo by Andrew Burton/Getty Images)

The U.S. economy shrank for the first time in three years during the first quarter, according to government data released Thursday morning, but many analysts believe the recovery has already regained its mojo.

Businesses depleted their inventories and cut back on investment in the first three months of the year, while harsh winter weather curtailed construction. As a result, the nation’s gross domestic product fell at an annualized rate of 1 percent. The government’s previous estimate had showed the economy essentially flatlining.

The decline highlights the fragility of the nation’s recovery but is not likely to derail it altogether. Several forecasts for the current quarter show the economy growing at a healthy 3 percent annual rate or faster.

"I think it just frankly coils the spring even tighter for a snapback this quarter," said Stuart Hoffman, chief economist at PNC Financial Services. "Boiiiing."

Wall Street shrugged off the report as old news. The major U.S. stock indexes were slightly up in mid-morning trading, with the tech-heavy Nasdaq leading the way with a 0.2 percent gain.

Consumer spending was particularly robust during the first quarter, jumping 3.1 percent despite the wickedly cold weather. Businesses also ramped up hiring as the temperature began to rise, suggesting stronger growth to come. Other government data released Thursday morning showed the number of people filing for unemployment benefits for the first time fell to 300,000 last week, a better showing than analysts expected. And there are no new major federal spending cuts weighing on the recovery.

But those bright spots were overshadowed by a drawdown in business inventories that subtracted 1.62 percentage points from economic growth during the first quarter. State and local governments decreased spending at a rate of 1.8 percent rate. Private and residential investment dropped off, while exports declined and imports rose -- all of which add up to weaker growth.

Still, the economic about-face in the first quarter could reflect the lingering damage of the recession. Analysts had predicted that housing would be a critical boost to the economy this year, but improvement in the beleaguered sector seems to have plateaued. The National Association of Realtors reported Thursday that its index of pending home sales inched up 0.4 percent in April, less than analysts had anticipated.  Lawrence Yun, the group's chief economist, said future gains will likely be slow and steady.

“Higher inventory levels are giving buyers more choices, and a slight decline in mortgage interest rates this spring is raising prospective home buyers’ confidence,” he said. “An uptrend in closed sales is expected, although some months will encounter a modest setback.”

Rates on a 30-year fixed mortgage dipped to a seven-month low last week, according to housing giant Freddie Mac, but they are still above the historic lows. Meanwhile, home sales have repeatedly clocked in below expectations. In congressional testimony earlier this month, Federal Reserve Chair Janet Yellen sounded a "cautionary note" on housing activity.

The central bank has spent more than $1 trillion to boost the recovery over the past year and a half, with nearly half of that money being pumped into the mortgage market. The Fed has been slowly phasing out its support but said it is monitoring financial conditions as it determines its next steps.

The government will update its estimate of economic growth two more times over the next few months before settling on the final number. According to Deutsche Bank economist Joseph LaVorgna, the average change over the past decade from the preliminary to the final estimate has been 1.47 percentage points.

"This means there is a very good chance that the final reading … will look a lot different than the initial figure," he wrote in a note to clients.