The Commerce Department said on Tuesday housing starts rose 1.7 percent to a seasonally adjusted annual rate of 546,000 units. June's housing starts were revised to show an 8.7 percent fall, which was previously reported as a 5 percent drop.

Analysts polled by Reuters had expected housing starts to rise to 560,000 units. Compared to July last year, groundbreaking activity was down 7 percent.

New building permits, which give a sense of future home construction, dropped 3.1 percent to a 565,000-unit pace last month, the lowest level since May 2009.

That followed a 1.6 percent rise in June and compared to analysts' forecasts for a slip to 580,000 units.

Separately, prices paid at the farm and factory gate rose 0.2 percent last month, pulled by higher prices for food and consumer goods, the Labor Department said.

The increase, which was in line with market expectations, was the first advance in producer prices in four months.

John Canally, economist at LPL Financial in Boston said the PPI data should ease some market concerns about deflation.

The end in April of a popular homebuyer tax credit has left a void in the housing market, depressing sales and building activity. Sentiment among home builders touched a 17-month low in August, a survey showed on Monday.

The rise in housing start last month reflected a 32.6 percent surge in groundbreaking activity in the volatile multifamily segment to an annual rate of 114,000 units. Single-family homes starts fell 4.2 percent to a 432,000-unit pace, the lowest since May 2009.

Home completions tumbled a record 32.8 percent to an all-time low 587,000-unit pace. The inventory of total houses under construction fell 1.1 percent to a record low 444,000 units last month, while the total number of units authorized but not yet started dropped 1.5 percent 89,000 units.

Meanwhile, industrial production rose in July on the strength of US manufacturing, as auto factories stayed open and businesses replaced worn-out equipment.

Output at America's factories, mines and utilities increased 1.0 percent last month, the Federal Reserve reported Tuesday.

Factory output, the largest single component of industrial production, grew 1.1 percent. It was the biggest jump in nearly a year. Boosting output were auto plants that kept operating when they normally shutter for summer renovations. Even without the strong auto sector, factory output rose 0.6 percent.

Business equipment production grew 1.8 percent, the most of any major market group. That number has remained positive since February, while consumer goods and construction supplies have been uneven.

The last time factory output increased so steeply was August 2009, when the government's "Cash for Clunkers" auto buying program drove a 1.3 percent gain.

The report did show that June's results were revised to show a 0.1 percent loss. That was the first decrease since the previous June.

Strong manufacturing growth should ease fears that the economy could fall back into a recession.

US factories were operating at 74.8 percent of their capacity, a .7 percent increase from June but still well below the historical average of 80.6 percent.