The first decline in private inventories in 1-1/2 years reported by the Commerce Department in its snapshot of first-quarter gross domestic product on Thursday is potentially good news for the economy this quarter as it faces a possible recession by year end. There had been fears that a correction of the inventory bloat would result in a sharper economic downturn.

Last quarter's decline raised hope that businesses were close to getting rid of unwanted stock, which would put them in a better position to rebuild inventory, should the need arise.

"Leaner inventories mean second-quarter GDP is on a solid foundation," said Chris Low, chief economist at FHN Financial in New York. "Of course, what is built on that foundation depends on many things, including job and income growth as well as confidence and credit availability."

Gross domestic product increased at a 1.1% annualized rate last quarter, the government said in its advance estimate of first-quarter GDP growth. The economy grew at a 2.6% pace in the fourth quarter. Economists polled by Reuters had forecast GDP rising at a 2.0% rate.

Private inventory investment declined at a $1.6 billion pace, the first decrease since the third quarter of 2021. The drop, led by wholesalers and manufacturers, followed a $136.5 billion rate of increase in the fourth quarter.

Economists said the drawdown appeared to be both planned as businesses were likely reluctant to add to stockpiles of unsold goods and the result of stronger consumer spending.

Inventories chopped off 2.26 percentage points from GDP growth, the most in two years, after adding 1.47 percentage points in the prior quarter. Business spending on equipment contracted for a second straight quarter. Overall business investment was tepid, likely due to narrowing profit margins.

Residential investment recorded its eighth consecutive quarterly drop though the pace of decline slowed considerably from the October-December period. Government spending picked up, while a smaller trade deficit contributed to GDP growth for the fourth quarter in a row.

Excluding inventories, trade and government spending, the economy grew at a 2.9% rate, the fastest since the second quarter of 2021. The surge in this measure of domestic demand, which was flat in the fourth quarter, was driven by a 3.7% rate of increase in consumer spending following the October-December period's pedestrian 1.0% pace of increase.

The jump in consumer spending, which accounts for more than two-thirds of U.S. economic activity, was led by increased purchases of motor vehicles as well as outlays on healthcare and Americans frequenting restaurants and staying at hotels.

The acceleration was accompanied by a rise in inflation. A measure of inflation in the economy, the price index for gross domestic purchases, rose at a 3.8% pace after increasing at a 3.6% rate in the fourth quarter. One of the measures tracked by the Federal Reserve, the core PCE price index jumped at a 4.9% rate after advancing at a 4.4% pace in the prior quarter.

The Fed is expected to raise interest rates by another 25 basis points next week, potentially the last hike in the U.S. central bank's fastest monetary policy tightening cycle since the 1980s. The Fed has increased its policy rate by 475 basis points since March of last year from the near-zero level to the current 4.75%-5.00% range.

Stocks on Wall Street were trading higher. The dollar gained versus a basket of currencies. U.S. Treasury prices fell.

LABOR MARKET TIGHT

Consumer spending last quarter, which was front-loaded in January, was fueled by an 8.0% rate of increase in income at the disposal of households after adjusting for inflation.

Disposable income was lifted by strong wage growth, and a rise in government social benefits. The saving rate increased to 4.8% from 4.0% in the fourth quarter.

But retail sales declined in February and March, while wage gains are slowing and most of the boost to income from social benefits has faded, setting up consumer spending on a slow growth path in the second quarter.

"The handoff to second-quarter spending is soft and the outlook for the consumer over the rest of 2023 is murky," said Michael Gapen, chief U.S. economist at Bank of America Securities in New York.

Still, consumer spending remains underpinned by a tight labor market, characterized by a 3.5% unemployment rate. A separate report from the Labor Department on Thursday showed initial claims for state unemployment benefits decreased 16,000 to a seasonally adjusted 230,000 for the week ending April 22.

Reduced access to credit for businesses and households is, however, seen hurting demand and ultimately hiring. There is also speculation that sluggish business investment could be flagging a change in behavior by corporations, which could impact employment.

The number of people receiving benefits after an initial week of aid, a proxy for hiring, fell 3,000 to 1.858 million during the week ending April 15, the claims report showed.

The so-called continuing claims data covered the period during which the government surveyed households for April's unemployment rate. They rose moderately between the March and April survey periods.

Economists are cautiously optimistic that any recession will be mild. Others believe a downturn could be entirely avoided. They noted that fears of a recession were pushing down prices of commodities like oil, which could help to reduce cost pressures for businesses and benefit the overall economy.

Oil prices have erased all their gains since the Organization of the Petroleum Exporting Countries and producer allies such as Russia announced in early April an additional output reduction until the end of the year.

"A U.S. recession is likely to start in the second half of this year," said Gus Faucher, chief economist at PNC Financial in Pittsburgh, Pennsylvania. "It should be mild, however, as consumer balance sheets remain strong, and the tight labor market will discourage layoffs."