June 26 (Bloomberg) -- Purchases of new homes in the U.S. dropped in May, signaling demand is still faltering in the second year of the housing slowdown.

Sales fell 1.6 percent to an annual pace of 915,000 last month from a revised 930,000 rate the prior month that was lower than previously estimated, the Commerce Department said today in Washington. The supply of unsold homes at the current sales pace rose.

A jump in mortgage rates this month and a glut of unsold properties on the market will continue to discourage home construction, economists said. The housing slump, already the worst since 1991, will restrain the economy for the rest of the year and potentially into next.

``The housing market should continue to be a drag to growth,'' said John Shin, an economist at Lehman Brothers Holdings Inc. in New York. ``Excess inventories and soft demand should keep homebuilders from increasing construction until after next year.''

Consumer confidence this month slumped to the lowest level since August as gasoline prices remained elevated and concern grew that the job market would weaken, a report today from the New York-based Conference Board also showed. The research group's gauge fell to 103.9 from 108.5 in May.

After the reports, the benchmark 10-year U.S. Treasury note was little changed, yielding 5.08 percent. Stocks were higher.

Less Than Forecast

Economists forecast new home sales would decline to a 924,000 annual pace from an originally reported 981,000 rate the prior month, according to the median estimate in a Bloomberg survey of 72 economists. Forecasts ranged from 850,000 to 990,000.

The increase in April sales was revised down to 13 percent, the biggest since September 1993, from 16 percent.

Home prices in 20 metropolitan areas dropped 2.1 percent in the year ended April, the biggest year-over-year decline since record keeping began in January 2001, according to a report today from S&P/Case-Shiller. The decline was led by a 9.3 percent drop in Detroit and a 6.7 percent fall in San Diego.

The median price of a new home fell 0.9 percent to $236,100 last month from $238,200 a year earlier, today's sales report from Commerce showed.

Inventories decreased less than sales, pushing up the months' supply. The number of homes for sale fell to a seasonally adjusted 536,000 during the month, and the supply of homes at the current sales rate rose to 7.1 months' worth from 7 months.

Sales of new homes were down 16 percent from the same time last year. The number of homes that are completed and waiting to be sold fell by 2,000 to 177,000.

Regional Breakdown

Purchases dropped in three of four regions. They fell 11 percent in the Northeast, 7.3 percent in the South and 1.9 percent in the West. Sales jumped 31 percent in the Midwest.

A report yesterday from the National Association of Realtors showed sales of previously owned homes fell in May to the lowest level in almost four years, while the supply of unsold homes jumped to a record.

Economists consider sales of new homes a timelier gauge of market demand because they are recorded when a contract is signed. Home resales are compiled mainly from contract closings that may reflect contracts signed weeks or months earlier.

Purchases of new homes account for about 15 percent of total home sales and existing homes account for the rest.

Other reports this month pointed to continued weakness in housing. Home starts fell for the first time in four months in May, the Commerce Department said last week. Homebuilder confidence plunged this month to the lowest since February 1991, an index from the National Association of Home Builders/Wells Fargo also showed.

`Deteriorating' Conditions

``We continue to see weak, and perhaps deteriorating, market conditions,'' Stuart Miller, chief executive officer of Lennar Corp., said in the statement today. ``We currently expect to be in a loss position in our third quarter.''

Miami-based Lennar, the largest U.S. homebuilder, today reported an unexpected loss for the quarter ended May 31 and said losses may persist into the next three months. New orders last quarter dropped 31 percent even as incentives rose 77 percent.

The drop in sales is hurting some merchants. Bed Bath & Beyond Inc., the largest U.S. home-furnishings retailer, earlier this month said first-quarter profit trailed an earlier forecast.

``The overall retailing environment, especially sales of merchandise related to the home, has been challenging,'' Chief Executive Officer Steven H. Temares said in a statement June 4.

Subprime

Rising defaults among subprime mortgage borrowers, those with poor or limited credit histories, may further depress sales by throwing more properties on the market. The number of Americans who may lose their homes because of late mortgage payments rose to a record in the first quarter, the Mortgage Bankers Association said this month.

A jump in mortgage rates is making borrowing more expensive even for those with good credit. The average rate on a 30-year fixed loan rose to 6.74 percent in the week ended June 14, the highest since July 2006, according to figures from Freddie Mac, the No.2 buyer of U.S. mortgages.

``The strong headwinds haven't abated at all,'' Bill Hampel, chief economist at the Credit Union National Association in Washington, said in an interview yesterday. ``Tightening mortgage credit, coupled with affordability issues, will slow the recovery.''

For their part, Federal Reserve policy makers have been more sanguine on the outlook for housing and the economy. Fed Chairman Ben S. Bernanke said this month that restrictions on the availability of mortgage credit will slow housing demand. At the same time, he and other officials have said the slump hasn't spilled over into other parts of the economy.

Policy makers are forecast to hold their interest-rate target at 5.25 percent for an eighth consecutive meeting later this week.

A pickup in manufacturing and a smaller trade deficit will help the economy rebound this quarter, even as housing continues to struggle, economists said. Growth slowed to an annual pace of 0.6 percent in the first three months of 2006, the weakest in four years.

To contact the reporter on this story: Shobhana Chandra in Washington schandra1@bloomberg.net

Last Updated: June 26, 2007 10:27 EDT