Oct. 20 (Bloomberg) -- Builders in the U.S. broke ground on fewer homes than forecast and wholesale prices unexpectedly fell in September, giving the Federal Reserve more reason to keep interest rates low to ensure an economic recovery.

Housing starts rose 0.5 percent to an annual rate of 590,000 from a 587,000 pace in August that was lower than previously estimated, a Commerce Department report showed today in Washington. Prices paid to factories, farmers and other producers fell 0.6 percent, the second drop in three months, the Labor Department said.

Builders may be paring back in anticipation of the end of the government’s $8,000 tax credit for first-time homebuyers on Nov. 30. The decline in producer prices confirms the Fed’s view that inflation is “subdued,” helping Fed Chairman Ben S. Bernanke and fellow policy makers fulfill a pledge to keep the benchmark rate at a record low for an “extended period.”

“Builders are a little bit cautious about the outlook,” said Zach Pandl, an economist at Nomura Securities International Inc. in New York. “There is still a huge amount of slack in the economy, and downside risks for inflation.”

Builder shares fell after the housing report, with the Standard & Poor’s Homebuilder Supercomposite Index closing down 2.1 percent. The S&P 500 Index decreased 0.6 percent to 1,091.06. Treasuries rose, pushing the yield on the 10-year note down to 3.34 percent at 4:18 p.m. in New York from 3.39 percent late yesterday.

Lower Than Forecast

Economists forecast starts would increase to a 610,000 rate, from a previously reported 598,000 in August, according to the median of 76 projections in a Bloomberg News survey. Estimates ranged from 582,000 to 630,000.

The National Association of Home Builders/Wells Fargo’s confidence index, released yesterday, unexpectedly declined in October on concern the expiration of the first-time homebuyer tax incentive would reduce demand.

Realtors and home builders are urging Congress to extend the incentive, and Treasury Secretary Timothy Geithner said last month that the Obama administration plans to take a “careful look” at the proposal.

Some lawmakers are calling for extending the tax credit to boost home sales.

“The work of stabilizing the housing market won’t be done” when the credit expires next month, Senate Banking Committee Chairman Christopher Dodd told a hearing of his panel today. “We still need to use every tool at our disposal to fix this problem.”

Former Realtor

Dodd, a Democrat from Connecticut, and Republican Senator Johnny Isakson of Georgia, a former Realtor, urged their colleagues to extend the credit through next June and to expand it to all couples earning $300,000 or less.

D.R. Horton Inc., the largest U.S. homebuilder by revenue, is among companies projecting the recent improvement in some parts of the country will be sustained. The Fort Worth, Texas- based company said last month it is buying finished lots, rather than building on undeveloped land it already owns, to boost its construction pipeline in anticipation of a housing revival.

“There have been some small encouraging signs in our sales and our average sales prices,” Bill W. Wheat, D.R. Horton’s chief financial officer, said on a Sept. 30 call with investors. Areas such as Las Vegas and Phoenix were still struggling, he said.

Unemployment, Foreclosures

Rising unemployment and record foreclosures are among the hurdles for the industry. The jobless rate reached a 26-year high of 9.8 percent last month, according to the Labor Department. Foreclosures depress the values of existing homes, prompting builders to cut prices in order to compete.

Fed policy makers at their September meeting considered a relapse into recession a bigger risk than a near-term rise in prices, according to minutes of the gathering released last week. They decided to slow purchases of mortgage securities to avoid disrupting the housing market while extending the duration of the program by three months.

Building permits fell 1.2 percent to a 573,000 annual rate last month. They were forecast to climb to a 595,000 pace from 579,000 in August.

Construction of single-family homes, which account for about 85 percent of the industry, increased 3.9 percent to a 501,000 rate. Work on multi-family units, which make up the rest of the market and is often volatile, slumped 15 percent to an 89,000 rate.

Regional Breakdown

The entire gain in starts was attributed to a 7.1 percent increase in the South. The other three regions fell, led by an 8.8 percent decrease in the West.

Economists forecast producer prices would remain unchanged, according to the median of 75 forecasts in a Bloomberg News survey.

Energy costs dropped 2.4 percent, led by a 9.8 percent fall in heating oil and a 5.4 percent decline in gasoline.

Excluding food and fuel, so-called core prices declined 0.1 percent, today’s Commerce Department report showed. Core prices had been projected to increase 0.1 percent, according to the Bloomberg survey.

The decrease in core costs reflected a 1.4 percent decline in light trucks and cheaper pet food. The cost of passenger cars gained 1 percent after the government’s “cash-for- clunkers” trade-in program expired in August.

Last week, the government reported consumer prices rose 0.2 percent in September after increasing 0.4 percent a month earlier.

Fed Vice Chairman Donald Kohn last week said inflation and growth will probably stay below the central bank’s objectives for some time, warranting low interest rates for an “extended period.”

To contact the reporters on this story: Courtney Schlisserman in Washington cschlisserma@bloomberg.net; Bob Willis at bwillis@bloomberg.net

Last Updated: October 20, 2009 16:23 EDT