Sales of new homes dropped a record 32.7 percent in May to the lowest level in at least four decades as the boost from a popular tax credit faded, adding to worries over a slowing economic recovery.

Single-family home sales tumbled to a 300,000 unit annual rate, the lowest level since the series started in 1963, the Commerce Department said on Wednesday.

The gloomy report was the latest to imply the economy's recovery from the most painful downturn since the 1930s might be losing strength, but few analysts expect a double-dip recession.

This tends to reduce expectations for second quarter growth. We are going to go through a period where home sales are extremely depressed before we see a recovery take hold, probably late this year, said Mark Vitner, senior economist at Wells Fargo Securities in Charlotte, North Carolina.

The Federal Reserve toned down its assessment of the economy, describing the recovery as proceeding in a statement at the end of its two-day policy meeting. In April, it had viewed the economy as continuing to strengthen. The U.S. central bank left overnight lending rates in the zero to 0.25 percent range set in December 2008.

Not only did new home sales in May miss market forecasts for a 410,000 unit-pace, figures for the prior two months were revised down sharply. That indicated the lift from the homebuyers' tax credit was not as large as previously thought.

The weak housing report and the Fed's downgraded assessment of the recovery caused a volatile session on Wall Street. The broader Standard & Poor's 500 index ended down 0.3 percent and the blue chip Dow Jones industrial edged up 0.05 percent.

U.S. Treasury debt prices rose, while the dollar fell against the yen and euro.

Data from retail sales to employment have pointed to a moderation in the pace of the economic recovery that started in the second half of 2009. Against the backdrop of a fragile economy and a sovereign debt crisis in Europe, analysts do not see the Fed raising interest rates until sometime in 2011.

There's no rate hike expected for the foreseeable future. At least not until the end of the year, if not 2011. The Fed is concerned about threats to growth, not threats to inflation, said Michael Woolfolk, senior currency strategist at BNY Mellon, in New York.

HOME LOAN DEMAND PLUMMETS

The expiry of the tax incentive for home buyers has also resulted in a decline in new home construction and a big drop in demand for home loans.

The Fed softened its view of home construction, saying housing starts remain at a depressed level. It previously described groundbreaking activity as having edged up.

To qualify for the tax credit, prospective home owners had to sign contracts by April 30. Since then, applications for loans to buy homes have fallen sharply. Last week they dropped for the sixth time in seven weeks, staying near 13-year lows.

New home sales are measured at contract signing. A report on Tuesday showed sales of previously owned homes, which are recorded at contract closing, also fell in May.

Last month's weak new home sales pace saw the supply of homes available for sale jumping a record 46.6 percent to 8.5 months' worth, the highest in nearly a year, from 5.8 months' worth in April. However, the number of new homes on the market dipped to 213,000 units, the lowest since November 1970.

The median sale price for a new home fell 1.0 percent in May from April to $200,900. In the 12 months to May, prices fell 9.6 percent, the largest decline since July 2009.

Although mortgage rates are near record lows, a deluge of foreclosed properties is stifling recovery.

The number of newly initiated foreclosures rose 18.6 percent to 370,856 in the first quarter, a separate report from U.S. banking regulators showed. However, delinquencies on home mortgages fell for the first time in more than two years.

(Additional reporting by Corbett Daly; Editing by Andrew Hay)

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