The nation's businesses continue to reduce excess inventory as they cut costs and re-align their operations with consumer demand. Business inventories fell in 1.1 percent in June, the U.S. Commerce Department announced Thursday, led by a decline in retail inventories.

Economists surveyed by Bloomberg News had expected inventories to decline 0.8 percent in June. Inventories fell a revised 1.2 percent in May and 1.3 in April. What's more, inventories have fallen 9.8 percent in the past year, and have declined for 10 straight months.

Meanwhile, sales rose 0.9 percent in June, after dipping 0.1 percent in May. Sales have declined 18 percent in the past 12 months.

Businesses adjust inventories to new era

With inventories falling faster than sales, the inventory-to-sales ratio declined again. The ratio, an indicator of demand, fell to 1.38 in June from 1.42 in May. The ratio was at 1.43 in April. A year ago, the ratio was 1.28.

In general, economists prefer to see business inventories decline during a recession, as it has historically indicated that business are bringing inventories back in line with reduced demand, taking excess supply out of the system. That draw-down has historically set the stage for both production increases and some job additions, once the economic recovery starts.

Further, the decline in retail inventories in June is consistent with structural changes in the nation's retail sector. Americans have decreased their discretionary purchases after a decade of unsustainable, debt-fueled overconsumption, and ushered in a "frugal consumer" era. And retailers are taking no chances by storing products they're not likely to sell soon: retail inventories are 11 percent lower than they were a year ago, the Commerce Department said.

Economic Analysis: Once again in June, companies did their best to reduce inventories, and if historical business and inventory cycles are any indicator, manufacturers should start to increase production in Q3. Add a modest increase in both consumer and business demand, and GDP will likely turn positive in Q3. Of course, there's no guarantee that producers will receive modest support from the new "frugal consumer," but given the length of the recession, the inventory decline length, and assuming a decent increase in exports, the argument is tipped in favor of an economic recovery in the second half of 2009. Also, the U.S. government's "cash-for-clunkers" car program should help deplete auto manufacturer inventories, and provide additional impetus for auto companies to increase production, further supporting U.S. GDP.

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