WASHINGTON - U.S. housing starts and building permits dropped to record lows in January, data showed Wednesday, as builders shelved construction plans to try to clear a glut of unsold houses caused by a slump in demand.

The data came as President Barack Obama unveiled a plan pledging up to $275 billion to help stem home foreclosures in an attempt to break the housing sector's downward spiral, which has plunged the U.S. economy into recession and swamped the global financial system with bad debts.

Further darkening the picture for an economy mired in a 13-month old downturn, U.S. industrial production shrank more than expected in January, while the amount of manufacturing capacity being tapped hit its lowest level on record.

The reports tell us that the recession is deepening and the risk of deflation is growing. We continue to see this adverse feedback between the housing market and the weakening economy, said Sal Guatieri, an economist at BMO Capital Markets in Toronto.

Housing starts tumbled 16.8 percent last month to an annual rate of 466,000 units, the lowest since the Commerce Department started keeping records in 1959.

It was the biggest percentage drop since January 1994, the department said. Analysts polled by Reuters had expected an annual rate of 530,000 units for January.

U.S. stocks brushed aside the grim housing data, with investors focusing on the Obama administration's plan to combat a rising tide of home foreclosures. That took some steam off government bond prices, which normally benefit from data showing increased stresses in the economy.

New building permits, which give a sense of future home construction, dropped 4.8 percent to a 521,000 unit pace, also an all-time low.

Compared to the same period in 2008, housing starts were down a record 56.2 percent in January, with permits off 50.5 percent. Housing completions slumped a record 41.7 percent.

FINDING A SILVER LINING

Some economists said the slump in groundbreaking for new homes and future building plans, while distressing, was necessary given the huge stock of unsold homes.

Do we really want housing starts to rise with housing inventories still close to record levels relative to sales? No, we don't, said Michael Darda, chief economist at MKM Partners in Greenwich, Connecticut.

So while this means the economy will be very weak in the near term, cutting down excess housing inventories is a critical component of getting home prices to stabilize.

The withering economy is driving unemployment higher and contributing to a deluge of bank repossessions, depressing house prices and creating a negative feedback loop that threatens to worsen the recession.

Restoring stability to the housing sector is critical to any economic recovery. Growing joblessness, combined with the housing and stock market collapse, has left households feeling poorer, leading consumers to cut spending sharply.

A separate report from the Federal Reserve showed industrial production dropped by 1.8 percent in January, steeper than analysts had expected. December's figure was revised lower to show a 2.4 percent decline.

The amount of the nation's industrial capacity being put to use last month fell to 72 percent, 8.9 percentage points below its long-run average. Manufacturing capacity use dropped to 68 percent, the lowest since the data series began in 1948.

This is consistent with massive deflationary forces in the goods sector, since the U.S. experience on capacity utilization is being repeated globally, said Alan Ruskin, chief international strategist at RBS Greenwich Capital in Greenwich, Connecticut.

In addition, it points the way to an ongoing collapse in business investment, that will be a major drag on growth through this year at a very minimum.

There was some glimmer of hope as other reports showed retail sales rose last week and applications for U.S. home mortgages soared after fixed mortgage rates dropped below 5 percent. The Mortgage Bankers Association said its index of mortgage application activity jumped 45.7 percent in the week ended February 13 to its highest reading since January 16.

Separately, the Labor Department said U.S. import prices fell by the smallest amount in six months in January as a string of double-digit declines in petroleum import prices ended.

(Additional reporting by Doug Palmer and Emily Kaiser in Washington and Al Yoon in New York; Editing by Andrea Ricci)

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