width=364Home building increased at a much weaker pace than expected in July, though sturdy growth in industrial output implied the embattled economy has enough strength to keep growing.

Tuesday's mixed batch of data also showed a tick up in producer inflation last month, which some analysts said helped ease concerns of a damaging downward spiral of falling prices amid an ebb in momentum in recovery from the longest and deepest downturn since the 1930s.

Worries of deflation and a double-dip recession have dominated investor sentiment in recent weeks, but economists generally believe the fears are being overplayed.

The data don't suggest that we are heading for a double-dip, the data do confirm that we are in a very subdued recovery. We continue to have a mixed picture with other sectors lagging and others leading, said Julia Coronado, an economist at BNP Paribas in New York.

Weak homebuilding data provided a bleak backdrop for a closely watched conference of housing experts hosted by U.S. Treasury Secretary Timothy Geithner to discuss how to restructure the mortgage financing sector.

The consensus seemed to be that the government must have some role in ensuring would-be homeowners can get money to buy houses so that the hard-hit housing industry can recover.

Housing starts rose 1.7 percent to a seasonally adjusted annual rate of 546,000 units, the Commerce Department said, but below market expectations for a 560,000-unit pace.

New building permits, which give a sense of future home construction, dropped 3.1 percent to a 565,000-unit pace last month, the lowest level since May 2009. Financial markets had expected a 580,000-unit rate.

Separately, industrial output jumped 1 percent last month after slipping 0.1 percent in June, the Federal Reserve said.

On the inflation front, prices paid at the farm and factory gate rose 0.2 percent in July for their first advance in four months, while core producer prices excluding food and energy increased 0.3 percent, other government data showed.


Against the backdrop of growing deflation talk, analysts welcomed the rise in core PPI.

Core pipeline price pressures are gradually building across most consumer-related sectors, said Peter Newland, an economist at Barclays Capital in New York.

This supports our view that the chances of a period of outright deflation in core consumer prices remain slim despite the apparent loss of momentum in the broader recovery.

Stocks on Wall Street brushed aside the mixed economic data, with all three indexes ending firmly higher after bellwether retailers Wal-Mart Stores Inc and Home Depot Inc recorded better-than-expected profits. But Wal-Mart warned the U.S. consumer remained under pressure.

The slow economic recovery will continue to affect our customers, and we expect they will remain cautious about spending, Wal-Mart Chief Executive Mike Duke said.

Prices for U.S. government debt fell on easing fears of deflation and also after Monday's hefty gains that pushed yields to multi-month lows. The U.S. dollar rose against the Japanese yen.

The slowdown in economic growth is largely a reflection of the waning of some government stimulus programs, including a popular homebuyer tax credit.

The end of the tax credit in April has left a void in the housing market, depressing sales and building activity. Sentiment among home builders touched a 17-month low in August, a survey showed on Monday.

Geithner told the conference there was a strong case for a carefully designed government guarantee for mortgages.

Without such support, the risk is that future recessions could be more severe because the financial system would not have the capital to support mortgage lending on an adequate scale, Geithner said. House price declines could be more acute, with even greater damage to financial wealth.

While housing starts increased overall last month, this reflected a 32.6 percent surge in groundbreaking activity in the volatile multifamily segment. Single-family homes starts fell 4.2 percent to their lowest level since May 2009.

Home completions and the number of homes under construction were the lowest on record last month.

The industrial production report, though, confirmed the strength in manufacturing remained.

Last month's rise in industrial output was double what markets had expected and gains were across the board, with automotive products surging nearly 9 percent.

Capacity utilization, a measure of how fully firms are employing their resources and a key benchmark for monetary policy, rose to 74.8 percent, the highest since September 2008, when the financial crisis was raging.

(Additional reporting by Doug Palmer and Pedro Nicolaci da Costa; Editing by Chizu Nomiyama)