Jan. 8 (Bloomberg) -- The homebuilding industry is about to stop hurting the U.S. economy and later this year may start to help it.

The housing demand that is beginning to stir may be unleashing faster growth. While housing won't add much to the expansion before the end of 2007, it's becoming less of an impediment as price cuts, incentives and lower mortgage rates bring more buyers into the market.

``The worst of the drag on the economy from construction is behind us,'' says Chris Varvares, president of St. Louis-based Macroeconomic Advisers Llc. As a result, he says, growth should pick up to an annual rate of more than 3 percent in the second quarter, from 2-1/4 percent in the current quarter.

That would lessen pressure on the Federal Reserve to reduce interest rates, disappointing bond investors who are anticipating that Fed Chairman Ben S. Bernanke and his colleagues will cut them as soon as May.

The yield on the 10-year Treasury note rose to 4.65 percent on Jan. 5 from 4.42 percent on Dec. 4 as strong job growth and rising incomes prompted bond investors to scale back their bets on Fed rate cuts. An index of housing shares soared 11 percent in the final two months of 2006, outstripping the 2.9 percent advance in the Standard & Poor's 500.

`Forward-Looking'

``Investors are very forward-looking, and there's a sense among them that a change in momentum in the housing market is approaching,'' says Robert Curran, managing director at credit rating company Fitch Inc. in New York.

Since Jan. 1, homebuilder shares have pared most of their gains of late last year. The Standard & Poor's Supercomposite Homebuilding Index fell 2 percent today and is down 6.4 percent for 2007.

Sales of existing homes rose in October and November, the first back-to-back monthly gain since late 2005. New-home sales are up too, helping pare the number of unsold properties to 545,000 from a record 573,000 in July.

Builders still view current conditions as poor, according to a December survey by the National Association of Home Builders/Wells Fargo. For the third month in a row, though, the survey showed an increase in the number of builders forecasting higher sales in six months' time.

``There are early indications of better times ahead,'' Ara Hovnanian, chief executive officer of Red Bank, New Jersey-based Hovnanian Enterprises, the state's largest homebuilder, said on Dec. 19.

Dancing on the Bottom

Toll Brothers Inc., the nation's largest luxury home builder, ``may be seeing a floor in some markets,'' says Robert Toll, chief executive officer of the Horsham, Pennsylvania-based company. Buyer ``deposits and traffic, although erratic from week to week, seem to be dancing on the bottom or slightly above.''

The industry may take its time getting up off the bottom. ``In the wake of the boom we had and the bust that we're having, it wouldn't surprise me to see a long period of not much growth in housing because that's what it needs to rebalance supply and demand,'' says Richard Berner, chief U.S. economist at Morgan Stanley in New York.

A revival of home building won't add to gross domestic product at anything like the pace of mid-2005, at the height of the housing boom, when residential construction accounted for more than a third of the economy's 3.3 percent growth rate.

``Tentative signs have begun to emerge that the housing market may be stabilizing,'' Federal Reserve Vice Chairman Donald Kohn said today in a speech in Atlanta. ``Housing starts may be not very far from their trough.'' Still, if they stay at current levels, ``construction activity would remain a negative for the growth of economic activity in the first half of this year,'' he said.

A Big Improvement

Macroeconomic Advisers' Varvares sees home building contributing just 0.1 percentage point to growth by the fourth quarter of this year. Still, that would be a big improvement from the third quarter of 2006, when housing pulled growth down by 1.2 percentage points to an annual rate of 2 percent.

David Seiders, chief economist at the National Association of Home Builders in Washington, looks for the industry to do much better. He sees home building adding as much as 0.7 percentage point to fourth-quarter growth.

Affordability

Behind the improving outlook: More people are able to afford homes. The rate on a 30-year fixed-rate mortgage has remained under 6.2 percent since mid-November, down from 6.8 percent in July. Applications for mortgages to purchase homes at the end of December were up 8.3 percent from their low for 2006, reached in October. The median price of existing homes, which account for 85 percent of the housing market, was down 3.1 percent in November from a year ago, the fourth consecutive monthly decline.

While new-home prices are still higher than a year ago, builders are providing more generous incentives to unload properties.

``They may not be taking off the top price, but by throwing in options, landscaping, mortgage buy-downs, they are making it more affordable to buy a house,'' says Curran. ``That will stimulate demand.''

Rising Incomes

In addition, incomes are rising after years of stagnation. Weekly earnings adjusted for inflation were up 2.6 percent in November over the same month a year earlier, after declining in 2005.

The long-term prospects for the U.S. housing market are more favorable than in other countries that experienced similar housing busts, says Mark Vitner, senior economist at Wachovia Corp. in Charlotte, North Carolina.

Housing prices surged this decade in Australia and the U.K., peaking earlier than in the U.S. Falling prices and sales in those countries proved only a temporary drag on economic growth, followed by rapid recovery.

The U.S. may fare even better because its younger population and higher rate of immigration create more room to increase homeownership rates, Vitner says.

``Housing recessions didn't bring about the end of the world in those countries, and our demographics are much more favorable,'' says Vitner.

To contact the reporters on this story: Matthew Benjamin in Washington at mbenjamin2@bloomberg.net; Rich Miller in Washington at rmiller28@bloomberg.net

Last Updated: January 8, 2007 13:15 EST