The American economy shrank at the end of 2007 and grew less than forecast in this year’s second quarter, signaling that the country is in worse shape than investors had anticipated.

“We’re in a recession,” the chief economist at Decision Economics Inc. in New York, Allen Sinai, said in a Bloomberg Television interview. “It’s going to widen, it’s going to deepen.”

The last time the economy contracted was in 2001. It may weaken further as the temporary boost from tax rebates, which aided a pick-up in gross domestic product last quarter from the previous three months, fades. Stocks dropped, Treasuries rallied and traders reduced bets that the Federal Reserve will raise interest rates this year.

“This confirms the general picture of weakness, but it is surprising that GDP declined,” the former head of the National Bureau of Economic Research and a member of the group’s recession-dating panel, Martin Feldstein, said. He added that yesterday’s figures underscored his estimate that a downturn began in December or January. “I don’t see a recovery” on the horizon, he said.

Gross domestic product increased at a 1.9% annualized rate, the Commerce Department said in Washington, compared with the median projection of 2.3% in a Bloomberg News survey. The Labor Department said separately that more Americans filed claims for unemployment insurance last week than at any time in more than five years.

Yields on benchmark 10-year Treasuries dropped to 3.95% from 4.05% late Wednesday. The Standard & Poor’s 500 Stock Index declined 1.3% to close at 1,267.38.

“As we look forward, we realize we have to grow out of a deeper hole than we thought,” the chief investment officer at Harris Private Bank in Chicago, Jack Ablin, said. “We’re going to operate at a kind of lackluster growth rate for many quarters to come.”

The smallest trade deficit in seven years, helped by the weakening American dollar, prevented the economy from shrinking again last quarter. The trade gap narrowed to a $395.2 billion annual pace, adding 2.4 percentage points to growth, the most since 1980. Excluding trade, the economy would have contracted at a 0.5% pace, the second such decline in the last three quarters.

Exports may have also spurred a gain in the National Association of Purchasing Management-Chicago’s business activity index. The group said today its measure increased to 50.8 this month from 49.6 in June. Fifty is the dividing line between growth and contraction.

“Exports are making the difference between a near recession, or mild recession, and a deep recession,” the chief economist at Global Insight Inc., a Lexington, Mass., forecasting firm, Nariman Behravesh, said in an interview with Bloomberg Television. “We don’t really see a recovery until some time in the spring or summer” of 2009 for the economy, he said.

An adviser to Senator McCain said yesterday’s report shows the importance of keeping open to trade.

“While growth continues to be disappointing, trade provides one of the few bright spots,” McCain adviser Douglas Holtz-Eakin said in a statement.

A spokeswoman for Senator Obama, Linda Douglass, said Mr. McCain “doesn’t have any solutions for people who are struggling in this economy.”