Despite steep rates, new home sales in October rose to year's highest level.

WASHINGTON -- Despite rising mortgage rates, new home sales grew to their highest level this year in October, the government reported yesterday.

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In a development that again confounded analysts' predictions of a decline, sales of new single-family homes grew 1.3% to a seasonally adjusted annual rate of 726,000 units, the highest level this year, according to the Commerce Department. This was the fourth straight advance and followed a hefty 5.6% gain in September, which had previously been reported as a 2.6% rise.

"Certainly it's a surprise," said Henry Willmore, an economist at Chase Manhattan Bank. "The housing market's entire reaction to higher rates has been surprising."

For months now, economists have been predicting the housing market would soon embark on a gradual downturn as mortgage rates continued to rise, pricing more and more potential buyers out of the market. Such a downturn has yet to materialize.

Nonetheless, analysts still expect the housing sector will start weakening sometime soon.

"Ultimately, the [Federal Reserve] is going to win," said Mark Obrinsky, a senior economist at the Federal National Mortgage Association. "The Fed will likely tighten again and again." The Fed has raised short-term interest rates six times so far this year.

Fixed-rate 30-year mortgages have been rising steadily since hitting a low of about 6.8% a year ago. Rates averaged 8.9% in October, up from 8.65% in September and 8.5% in August.

Analysts said they are now more confident that home sales will soon begin to taper off because adjustable-rate mortgages have also begun to rise. ARMs averaged 6.1% in November, up from 5.79% in October and 5.53% in September, according to Dean Crist, a research economist at the National Association of Home Builders.

Low first-year ARM rates "cushioned and delayed" the impact of the Fed's first few rate increases earlier this year, Willmore said. Now that ARMs are rising, it's possible the housing market will begin a steeper decline than most analysts expect, especially if the Fed keeps aggressively raising rates, he said.

Lyle Gramley, a consulting economist with the Mortgage Bankers Association, predicted the Fed will continue aggressively raising rates but that the housing market will at best decline modestly in the coming months.

"This is an economy with strong underpinnings," Gramley said. Consumer confidence is very high because income and job growth have been strong for quite some time, he explained. "Households have shaken their dire feelings of economic insecurity and are willing to take on big financial commitments like a mortgage," he said.

The Fed's next policy meeting is on Dec. 20. Economists said it is too close to call whether Fed officials will raise rates at this meeting or wait until the following meeting on Jan. 31 and Feb. 1.

Gramley, a former Fed governor, predicted that the Fed will raise rates by 75 or 100 basis points at one of those meetings. And Obrinsky said he expects that short-term rates will be 100 basis points higher than current levels by early spring.

According to yesterday's report, October home sales were up in all regions except the Northeast, where they plunged 33% to 63,000. Sales climbed 14.4% in the West to 230,000; the Midwest gained 8.3% to 117,000; and the South inched up 0.3% to 316,000.

Despite recent gains, sales are not that much higher than they were this time last year. Compared with 12 months ago, home sales were up a slim 0.4% in October. And year-to-date, sales were up 4.6% compared to the first 10 months of last year.

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