Home sales fell in February, but upward revisions to the prior month's pace and the first yearly increase in prices in 15 months pointed to steady improvement in the housing market.

Existing home sales fell 0.9 percent in February from January but still notched their second highest level since May 2010, the National Association of Realtors said on Wednesday.

We are starting to improve slowly. There is some encouraging news, but the dramatic things that need to happen to really turn the market around aren't there, said Mitchell Hochberg, Principal at Madden Real Estate Ventures in New York.

Realtors say the labor market needs to strengthen significantly and banks must ease lending conditions, which every month result in about a third of contracts being canceled, for a decisive recovery to take root.

Job creation has stepped up in recent months, with employers adding a total of 734,000 jobs to their payrolls over the last three months. However, the unemployment rate remains at a very high 8.3 percent.

Despite the weak sales pace last month, the median home price rose 0.3 percent from a year ago to $156,600 - the first yearly increase since November 2010 - adding to signs of a budding recovery.

Data on Tuesday showed permits to build homes rose to a near 3-1/2 year high in February, and a report on Friday is expected to show new home sales increased last month.

Some economists said smoothing out the data to account for the extra day in February could have contributed to the surprise drop in sales last month. Economists polled by Reuters had expected sales to rise to a 4.62 million pace.

Using last year's seasonal adjustment factor instead of this leap year's, existing home sales would have actually risen by 3.0 percent month on month to 4.77 million units, said Ellen Zentner, an economist at Nomura Securities in New York.

The data had little impact on U.S. financial markets, though sales prices for Treasury debt saw some flight to safety trades.

SALES TRENDING HIGHER

Since bottoming around a 4.05 million-unit pace in July, home resales have largely held up.

Compared with February last year, sales were up 8.8 percent and according to JPMorgan economist Daniel Silver, the gains were tracking a seasonally adjusted annualized rate of 30 percent so far this quarter.

The unusually mild winter may have helped boost existing home sales in recent months, but we do not think this is the only factor driving up sales, said Silver.

The upward trend in the data began before the abnormal weather started, and we do not see a statistically significant relationship between deviations from normal temperatures and existing home sales during winter months.

But recovery will not be easy and mortgage rates have spiked in recent weeks. Demand for home loans fell last week partly in response to rising rates. Fixed 30-year mortgage rates increased 13 basis points to average 4.19 percent last week.

Sales last month were mixed, declining sharply in the Northeast and West. They were up in the Midwest and South.

The housing market continues to be choked by a glut of unsold properties, which are weighing down prices.

Last month, the inventory of unsold homes on the market increased 4.3 percent to 2.43 million units - representing 6.4 months' supply, up from 6.0 months in January. These number were not adjusted for seasonal fluctuations.

When adjusted for these variations, the months' supply edged down to 6.5 months' worth from 6.6 months in January. A supply of six months generally is considered ideal, with higher readings pointing to price declines.

Inventories are well below their 4.04 million units peak in July 2007 and in some parts of the country, which were not severely affected by the recession, realtors are actually short of property to sell.

Our biggest problem is the lack of inventory, said John Ford, owner of Ford Realty in Boston. If the property is priced correctly, we have bidding wars, said Ford, who operates in one of Boston's upscale areas.

A separate report from CoreLogic showed the number of properties in the foreclosure pipeline fell 11.1 percent to 1.6 million units in January from a year ago, representing 6 months' worth of supply.

Last month distressed properties - foreclosures and short sales - which typically occur at deep discounts, made up a third of overall sales last month.

Investors bought 23 percent of homes sold last month, with first-time buyers accounting for about a third of the transactions.

(Additional reporting by Jilian Mincer in New York; Editing by Diane Craft)