May 16 (Bloomberg) -- The U.S. housing slump may persist even as a pickup in manufacturing helps the economy avoid a recession, reports today showed.

Building permits slumped 8.9 percent in April to an annual rate of 1.429 million, the lowest level in almost a decade, the Commerce Department reported today in Washington. At the same time, builders unexpectedly broke ground on more new homes. Industrial production rose 0.7 percent, the Federal Reserve said, more than economists anticipated.

The figures reinforce Fed forecasts that the housing slump won't bring the six-year economic expansion to a halt. The improvement in manufacturing will help compensate for a slowdown in consumer spending, which has driven growth for the past two quarters.

``Housing is in recession, but it doesn't seem to be spilling over into the rest of the economy,'' said Nariman Behravesh, chief economist at Global Insight Inc. in Lexington, Massachusetts, and a former Fed economist. ``The good news is that manufacturing is rebounding.''

Building permits, an indication of future construction, dropped to the lowest level since June 1997. Housing starts rose 2.5 percent to an annual rate of 1.528 million in April, the highest this year.

Starts were projected to fall to a 1.48 million pace in April, from an originally reported 1.518 million the previous month, according to the median forecast of economists polled by Bloomberg News. The previous month's figures were revised lower.

Economists had forecast industrial production would rise 0.3 percent after a previously reported decline of 0.2 percent the prior month, based on the median of estimates in a separate survey.

Guide to Future

Some buyers are delaying purchases in anticipation of a drop in home prices as stricter lending guidelines and subprime mortgage defaults add to the glut of unsold properties, economists said. The housing recession remains the biggest threat to the Fed's forecast of ``moderate'' economic growth.

``The drag from housing is going to continue for a while,'' said James O'Sullivan, a senior economist at UBS Securities LLC in Stamford, Connecticut. ``The decline in permits suggests starts will weaken further.''

Construction of single-family homes rose 1.6 percent last month to a 1.225 million rate, the most this year, today's report showed. Work on multifamily homes, such as townhouses and apartment buildings, increased 6.3 percent to an annual rate of 303,000.

Regional Differences

The increase in housing starts was led by a 31 percent jump in the Northeast and a 7.8 percent gain in the West. Starts fell 14 percent in the Midwest and were down 0.1 percent in the South.

Factory output, which accounts for about four-fifths of industrial production, rose 0.5 percent led by gains in motor vehicles, computer and electronics gear. The coldest April in a decade also increased home-heating demand, boosting overall production.

``The manufacturing part of the economy is going back on stream,'' said John Silvia, chief economist at Wachovia Corp. in Charlotte, North Carolina.

A report yesterday showed builders became more pessimistic this month. The National Association of Home Builders/Wells Fargo sentiment index fell to 30 from 33 in April. The reading matched September's figure as the lowest since 1991. Readings below 50 mean most respondents view conditions as poor.

The failure of at least 50 subprime lenders, who make loans to consumers with poor or limited credit history, has raised concern more homes will be thrown back on the market as foreclosures rise.

Tighter Credit

So far, there is little evidence that the subprime crisis is affecting other types of mortgage lending. More than half the lenders surveyed by the Fed last month said they tightened credit standards on subprime mortgages, according to the central bank's quarterly survey of senior loan officers published May 14.

Still, only 15 percent of respondents said they also restricted credit to better-rated borrowers, the Fed report said.

Residential investment, which subtracted 1 percentage point from economic growth in the first quarter, is likely to remain weak in coming quarters, economists said. Fed policy makers have looked beyond housing to forecast the economy will keep expanding.

`Ongoing' Adjustment

``The adjustment in the housing sector is ongoing,'' Fed policy makers said in a May 9 statement announcing they'd kept the benchmark interest rate unchanged at 5.25 percent. ``Nevertheless, the economy seems likely to expand at a moderate pace,'' they also said.

Toll Brothers Inc., the largest U.S. luxury home builder, said May 9 that profit in the quarter ended April 30 was lower than earlier predicted, and the company will miss its full-year earnings forecast.

``Twenty months into this housing downturn, we continue to face difficult conditions in most of our markets,'' Chief Executive Officer Robert Toll said in a statement.

The National Association of Realtors last week slashed estimates for new and existing home sales for this year and 2008. The group also said prices of existing homes will fall more than its prior forecast, and the median price for new homes will decline this year for the first time since 1991.

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

Last Updated: May 16, 2007 13:18 EDT