Customers choose purchases at a Home Depot store in Chicago. A weak housing market has hurt the national retailer.

AP / Charles Rex Arbogast

U.S. builders broke ground on the fewest new houses in 17 years and producer prices climbed the most since 1981, providing no sign of an economic recovery or easing inflation.

Housing starts fell 11 percent in July to an annual rate of 965,000, the Commerce Department said yesterday in Washington. And the Labor Department reported that the producer price index jumped 9.8 percent from a year before.

“There’s no doubt we’re in a period of stagflation now,” said Peter Kretzmer, a senior economist at Bank of America Corp. in New York who formerly worked at both the Federal Reserve Bank of New York and the Fed board in Washington.

“We are still in a fairly risky situation” on the inflation front, Fed Bank of Richmond president Jeffrey Lacker, said. He added that higher interest rates may be needed to curtail prices even before growth and financial markets return to normal.

Compared with July of last year, work began on 30 percent fewer houses. Building permits, a sign of future construction, also fell in July, the Commerce Department reported. They were down 18 percent to a 937,000 annual pace.

Starts were projected to fall to a 960,000 annual pace, according to the median forecast of 77 economists polled by Bloomberg News. The median estimate for permits was 970,000.

The decrease in starts was led by a 30-percent decline in the Northeast. Construction fell 8.2 percent in both the South and West. Starts in the West slumped to a 26-year low. The Midwest showed a 10 percent gain.

The magnitude of the July drop in the Northeast reflected, in part, a payback from an unexpected surge the previous month. Starts and permits jumped in June as builders hurried to break ground ahead of new regulations in New York City’s building code that took effect July 1.

“A recovery will not happen this year,” said Russell Price, a senior economist at H&R Block Financial Advisors Inc. in Detroit. “Not only are mortgage rates creeping up, but financing is becoming more difficult for a lot of people. Builders will continue to pull back.”

The 1.2-percent increase in producer prices from the previous month followed a 1.8-percent increase in June, the Labor Department said. So-called core prices that exclude fuel and food rose 0.7 percent after a 0.2-percent gain in June.

Prices paid to factories, farmers and other producers were forecast to rise 0.6 percent, according to the median of 77 forecasts. The core index was projected to advance 0.2 percent.

“The recent burst of cost-push inflation is giving the beast digestion problems that might manifest themselves in the form of a lingering inflationary fever,” Dallas Fed president Richard Fisher said in a speech in Aspen, Colo., yesterday.

The jump in the producer price index reflected a surge in commodity costs that has since waned. At the same time, the acceleration in costs excluding food and fuel raises concern about a pass-through to consumer prices.

Producer prices are one of three monthly inflation gauges reported by the Labor Department. Import prices rose 1.7 percent in July and consumer prices increased 0.8 percent for the same period, the Labor Department said last week. Both figures were higher than estimated.

Construction of single-family houses fell 2.9 percent to a 641,000 rate, the fewest since January 1991, yesterday’s report showed. Work on multifamily houses, such as townhouses and apartment buildings, dropped 24 percent from the previous month to an annual rate of 324,000.

“The news ahead for housing remains bad,” Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc. in New York, said. “There’s a corrective process we have to get through here.”

Underneath the housing gyrations, demand is weakening. Sales of existing houses fell to a 10-year low in the second quarter, according to the National Association of Realtors. A third of all sales were foreclosures or “short sales,” in which lenders take a loss on a property.

Financing is also becoming tougher, a quarterly survey of banks by the Federal Reserve showed. Compared with the April survey, more of the loan officers polled reported they tightened standards on prime mortgage loans and on non-traditional loans.

The slumping U.S. economy is taking its toll on retailers from luxury chain Saks Inc. to discounter Target Corp., reports showed yesterday. Saks reported its largest quarterly loss in two years, while profit dropped for a fourth straight quarter at Target. Home Depot Inc., the biggest home improvement chain, posted its seventh sales decline in eight quarters.

Falling retailer earnings may signal that the U.S. economy will deteriorate further as consumers rein in spending to cope with rising unemployment and inflation. Home Depot chief executive officer Frank Blake told analysts yesterday he was “cautious” about consumer spending through mid-2009.