Industrial production rose at its quickest pace in seven months in July as motor vehicle output rebounded strongly, further easing fears the economy could slide into recession.

Other data showed residential construction, while still depressed, was not a drag on the economy as the second half of the year got under way.

Industrial output increased 0.9 percent, the Federal Reserve said on Tuesday, after a 0.4 percent gain in June and well above economists' expectations for a 0.5 percent rise.

Manufacturing, which has been the economy's main pillar of support, rose 0.6 percent as motor vehicles production surged 5.2 percent after falling 0.9 percent in June.

This report suggests that the recovery may have regained some momentum in recent months, and it could go some way in easing fears of a impending recession, said Millan Mulraine, senior macro strategist at TD Securities in New York.

The economy barely grew in the first half of the year, held back by high gasoline prices and supply chain disruptions from Japan in the wake of the March earthquake. The industrial production data indicated the Japan-induced disruptions to manufacturing were fading.

Commerce Department data showed housing starts slipped a less-than-expected 1.5 percent in July to a seasonally adjusted annual rate of 604,000 units as builders broke ground on new multifamily units to meet demand for rental apartments. Economists had expected a 600,000 rate.

However, the housing market recovery continues to be hobbled by an oversupply of previously owned homes.

Housing starts remain somewhat range bound at historically low levels as homebuilders continue to reduce existing inventories of new single-family properties against a backdrop of elevated foreclosures, said Michael Gapen, an economist at Barclays Capital in New York.

That said, we look for starts activity to be less of a drag on the recovery going forward.

U.S. financial markets were little moved by the report as investors focused on weak euro zone growth data. Stocks on Wall Street opened lower, while prices for U.S. Treasury debt rose. The dollar firmed against a basket of currencies.

BLOATED INVENTORY

A bloated inventory of unsold homes and a weak economy are weighing down on the housing market, whose collapse was the main catalyst of the 2007-09 recession. A large foreclosure pipeline also is not helping, leaving builders with little incentive to break ground on new projects.

Sentiment among home builders was steady at low levels in August, a survey showed on Monday, but they were pessimistic about sales over the next six months.

But demand for rentals, as Americans shun homeownership because of plummeting home prices and a 9.1 percent jobless rate, is stemming further declines in home construction.

Last month, housing starts for multi-family homes rose 7.8 percent to a 179,000-unit rate, and groundbreaking for projects with five or more units was the highest since January.

Single-family home construction -- which accounts for a large portion of the market -- dropped 4.9 percent to a 425,000-unit pace.

New building permits fell 3.2 percent to a 597,000-unit pace last month. Economists had expected overall building permits in July to fall to a 605,000-unit pace.

Permits were dragged down by a 10.2 percent drop in the multi-family segment. Permits to build single-family homes rose 0.5 percent.

New home completions increased 11.8 percent to 636,000 units in July, the highest since June 2010.

(Reporting by Lucia Mutikani and Jason Lange; Editing by Andrea Ricci)