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(Reuters) – Housing starts fell in May from a 3-1/2 year high, although permits to build new homes rose sharply, suggesting a nascent housing recovery remains on track.

The Commerce Department said on Tuesday that groundbreaking on new homes dropped last month to an annual rate of 708,000 units, falling short of analysts’ expectations.

However, upward revisions to data for March and April put starts above 700,000 for five straight months, a first since 2008.

This highlights a big turn of events that is under way: while the broader U.S. economy appears to be losing steam, housing is gaining traction and has become a relative bright spot. Despite a sharp slowdown in hiring, home prices appear to be stabilizing and homebuilder sentiment has risen to a five-year high.

“The incipient recovery in housing market activity, in short, seems not to have been affected by the recent softening in much of the other economic data,” said Ian Shepherdson, an economist at High Frequency Economics in Valhalla, New York.

The decline in starts in May was entirely due to a 21.3 percent drop in groundbreaking for multi-family buildings, a volatile reading that is prone to substantial revisions.

Starts for single-family homes, which account for most of the market, increased 3.2 percent.

In another positive sign, new building permits jumped 7.9 percent in May to a 780,000-unit pace. That was the highest since September 2008 and well above analysts’ forecasts.

“Several aspects of the report paint a somewhat brighter picture than the headline suggests,” said Peter Newland, an economist at Barclays in New York.

For example, April’s starts were revised up to a 744,000-unit pace from a previously reported 717,000 unit rate. That was the highest reading since October 2008.

Many economists now predict home building will add to economic growth this year for the first time since 2005.

At the same time, Europe’s debt crisis and planned belt-tightening by the U.S. government loom heavily over an already struggling economy. Hiring has slowed every month since February and the Labor Department said on Tuesday that U.S. job openings dropped to a five-month low in April.

A downturn would imperil President Barack Obama’s hopes of re-election in November. The hiring slowdown has raised expectations the Federal Reserve could ease monetary policy when it concludes a two-day policy review on Wednesday.

U.S. stocks extended early gains as traders hoped for central bank stimulus measures.

(Editing by Andrea Ricci)