The housing market is converting into a tailwind for the broader economy as construction activity gains momentum at a double-digit pace and home prices finally rise, says Joseph LaVorgna, housing analyst at Deutsche Bank ($27.34 0%).

LaVorgna makes this claim despite the recent hiccup in house prices. New home sales declined 8.4% to 350,000 units in June, down from a revised rate of 382,000 the previous month, according to a new report from the U.S. Census Bureau and the Department of Housing and Urban Development.

This does not change the Deutsche Bank outlook. “This [overall] resumption in residential activity cannot be understated as the long awaited housing recovery should help buoy consumer confidence and provide a mild lift to second half economic output after what was likely a disappointing first half of the year,” he says.

In the first quarter, inflation-adjusted residential investment grew at a 20% annualized rate — a fourth consecutive increase — after a relatively large 11.6% gain in the previous quarter. The first-quarter construction surge, by itself, LaVorgna says, added 40 basis points to that period’s gross domestic product growth, which expanded by only 1.9% in the quarter.

Over the past year, residential investment advanced 9%, the fastest annual rate since the fourth quarter of 2004 when it grew 13%. Because this increase was off of a very low base, Deutsche Bank expects construction activity to continue to “rise at a healthy pace.”

Supply and Demand

The comments echo those made last week by Bank of America Merrill Lynch ($7.07 0%) housing analyst Michelle Meyer, who said a better alignment of housing supply and demand is adding to the continued recovery in the housing market, despite sluggish growth in the overall economy. 

Several years of extraordinarily slow construction, slow processing of foreclosures and reduced housing turnover is significantly reducing the inventory of homes for sale, Meyer said.

The inventory of new homes totaled just 1.74 million units in May, up only a smidgeon from April’s all-time record low of 1.73 million units. The same pattern exists for existing homes, where inventories have fallen since July 2007 when they stood at a record high of four million units.

The latest housing starts and permits point to another large gain in residential investment in the second quarter. “We expect housing to remain a bright spot in what is otherwise likely to be a disappointing quarter for real GDP growth of +1%,” LaVorgna says.

Second-quarter real GDP figures will be released Friday.

LaVorgna cites the elevation of home prices across the nation as a factor in the housing markets headwind reversal. However, Standard & Poor’s says to expect more price dips by year-end.

“We expect these drops to occur in tandem with new foreclosed properties reaching the market later this year,” S&P credit analyst Erkan Erturk says. “The U.S. economy is currently growing at too slow a pace to have an impact on the housing market, and we believe that certain economic factors, such as weak employment growth and the Euro debt crisis, could somewhat stymie the housing recovery.”

U.S. home prices for the 12-month period ending in May rose 3.7% over last year, the Federal Housing Finance Agency said Monday in its latest monthly House Price Index. Home prices grew a slight 0.8% from April to May, showing some signs of stability in the housing market.

Prices are now 34% below their mid-2006 peak. Standard & Poor’s expects it will take 11 years from now for home prices to climb back to their mid-2006 peak, assuming a home-price appreciation rate that is in line with a 4% household income growth rate.

The weather factor

Some analysts argue the surge in residential construction activity was due to unseasonably warm weather, which allowed builders to begin or continue construction during the traditionally slow winter period.

LaVorgna disagrees.

“If weather was the key factor lifting first-quarter housing construction, then we should have seen housing starts grow at a much faster pace than housing permits; in theory, the latter should not be distorted by the weather,” LaVorgna says. “This was not the case the analyst points out as housing permits grew 30.9% from third-quarter 2011 to the first quarter, a slightly slower pace than housing starts, which accelerated 35.8% in that period.

The housing improvement is also evident in sales as construction activity is paralleling home sales. New home sales rose 7.6% in May to 369,000 units, and arey are up 19.8% from a year earlier. Existing sales were down 5.4% in June to 4.37 million units, but are up 4.7% from their year-ago levels.

Pending home sales, which are homes in contract that have not yet closed and which lead existing home sales by a couple of months, increased 5.9% in May and are up a solid 13.3% over the past year.

“If we combine new and existing home sales, they are basically back to early 2008 levels excluding the brief surge in sales following the homebuyers’ tax credit,” LaVorgna says.