New home construction continues in Carlsbad, California June 24, 2008.REUTERS/Mike Blake

WASHINGTON - New construction of U.S. homes rose less than expected in September as ground-breaking activity for multi-family dwellings fell sharply, highlighting the economy's uneven recovery path.

The Commerce Department said on Tuesday housing starts rose 0.5 percent to a seasonally adjusted annual rate of 590,000 units, below market expectations for 610,000. August's housing starts were revised down to 587,000 units.

A separate report from the Labor Department showed producer prices dropped an unexpected 0.6 percent in September. Analysts had anticipated prices would remain unchanged after rising 1.7 percent in August.

The housing numbers still look somewhat soft and that's a reflection of weakness in the consumer. The low PPI numbers mean that the Fed is in a position to keep rates unchanged for a while, said Subodh Kumar, chief investment strategist at Subodh Kumar & Associates in Toronto.

U.S. stock futures, which were lifted earlier after strong quarterly results from bellwethers Apple and Caterpillar, trimmed their gains on the soft housing and price data.

New construction activity in the volatile multifamily segment dropped 15.2 percent to an annual pace of 89,000 units. Groundbreaking for single-family homes, the largest component of the housing market, rose 3.9 percent in September to an annual rate of 501,000 units.

Compared to September last year, housing starts were down 28.2 percent.

The housing market, the main catalyst of the worst U.S. recession since the 1930s, is crawling out of a three-year slump and residential investment probably contributed to economic growth in the third quarter, according to analysts.

New building permits, which give a sense of future home construction, unexpectedly fell 1.2 percent to an annual pace of 573,000 units in September, the Commerce Department said. That was the biggest percentage decline since April.

Analysts had forecast permits at 600,000 units. Building permits were down 28.9 percent compared to September last year.

A survey on Monday showed confidence among U.S. home builders edged down in October amid worries over the expiration of a $8,000 government tax credit for first-time buyers.

The incentive, which ends next month, has been widely cited as the main force behind the housing market's steady recovery.

Separately, prices paid at the farm and factory gate fell 4.8 percent on the year, which was steeper than forecasts for a 4.2 percent drop. Excluding food and energy, prices declined by 0.1 percent in September from the prior month, and were up 1.8 percent on the year.

The headline PPI numbers fuel the deflationary fears, said Doug Bender, managing director at McQueen, Ball & Associates in Bethlehem, Pennsylvania.

(Reporting by Lucia Mutikani and Lisa Lambert; Editing by Andrea Ricci)