WASHINGTON - The U.S. economy contracted at slower pace than previously thought in the second quarter, but a further decline in private payrolls in September was another indication that recovery from recession would be patchy.

The Commerce Department said on Wednesday gross domestic product fell at a 0.7 percent annual rate instead of the 1.0 percent decline reported last month. This was better than market expectations for a 1.2 percent drop.

GDP, which measures total goods and services output within U.S. borders, fell at a 6.4 percent rate in the January-March period.

A separate survey by the ADP Employer Services showed private employers 254,000 jobs in September more than the 210,000 layoffs the market had been expecting. However it was less than the 277,000 jobs lost in August.

It's (GDP) not an earth-shaking revision, but it does show a healthier picture than before because domestic spending is less weak. It's unlikely to change perceptions about the third-quarter outlook, said Pierre Ellis, a senior economist at Decision Economics in New York.

U.S. stock futures rose after the GDP report, regaining losses suffered after data on private sector employment showed more job losses than expected in September. Bond prices fell on the news, while the dollar rose against the euro.

The decline in GDP will probably mark the last quarter of contracting output for the U.S. economy, which slipped into recession in December 2007. The economy is believed to have rebounded in the July-September quarter.

With the second-quarter contraction, the country's real GDP has shrunk for four straight quarters for the first time since government records started in 1947.

The shallow decline in activity in the second quarter reflected more moderate drops in consumer spending and business investment than previously thought, the report showed.

Consumer spending, which normally accounts for over two-thirds of U.S. economic activity, fell at a 0.9 percent rate in the second quarter -- smaller than the previously estimated 1.0 percent decline. Spending rose at a 0.6 percent rate in the previous quarter.

Business investment fell at a 9.6 percent rate in the second quarter instead of 10.9 percent, reflecting slightly better demand for software than previously thought. It tumbled 39.2 percent in the first quarter.

SPENDING STILL WEAK

Weak domestic demand meant businesses continued to reduce their stock of unsold goods. Business inventories plunged by a record $160.2 billion in the second quarter rather than the $159.2 billion drop estimated by the government last month. Stockpiles of unsold goods fell by $113.9 billion in the first quarter.

The drop in inventories subtracted 1.42 percentage points from second-quarter GDP, the department said. Excluding inventories, GDP rose 0.7 percent in the second quarter compared to a 4.1 percent decline in the first quarter.

Rebuilding of inventories is expected to be one of the main drivers of the economy's recovery. Economists agree that the recovery, which is also aided by government spending, is already under way.

However there are doubts over its strength and sustainability because of weak consumer spending as the economy continues to bleed jobs.

The department said corporate profits after taxes rose 0.9 percent, much lower than the 2.9 percent it estimated last month. It compared to analysts' forecasts for 3.0 percent growth.

After tax corporate profits increased 1.3 percent in the first quarter.

Investment in nonresidential structures fell at a 17.3 percent rate compared to a 43.6 percent drop in the January-March quarter. Residential investment, at the heart of the worst U.S. recession in seven decades, dropped at a 23.3 percent rate in the second quarter. It fell 38.2 percent in the first quarter.

There was encouraging news on the trade front. Exports fell at a smaller 4.1 percent rate instead of the 5 percent drop reported last month, the department said. Exports plunged 29.9 percent in the first quarter.

There were positive contributions from the federal, state and local government during the second quarter.

A National Association of Purchasing Management-New York survey showed business activity in New York City surged to a near three-year high in September, building on recent optimism about local economic conditions.

Separately, the Mortgage Bankers Association said mortgage applications fell last week despite the lowest loan rates in four months, an indication the housing market would likely recover slowly from its three-year plunge.

(Reporting by Lucia Mutikani; Additional reporting by Camille Drummond, Burton Frierson, Lynn Adler and Ellen Freilich in New York; Editing by Andrea Ricci)

Jobs Fall