* Producer prices rise 0.2 percent in January
* Food accounts for three quarters of rise in PPI
* Core PPI gains 0.2 percent, year-on-year rate slows
* Housing starts tumble 8.5 percent, permits up 1.8 percent
By Lucia Mutikani
WASHINGTON, Feb 20 (Reuters) - U.S. builders broke ground on fewer homes last month but a jump in permits for future construction to a 4-1/2-year high indicated the housing market recovery remains on track.
Another report on Wednesday showed wholesale prices rose in January for the first time in four months. However, the gain was smaller than expected and left scope for the Federal Reserve to keep buying bonds to stimulate the economy.
Housing starts dropped 8.5 percent in January to an 890,000-unit annual rate, pulled down by a sharp drop in the volatile multi-family unit category, the Commerce Department said.
Starts for single-family homes hit their highest level since July 2008, and permits for future construction, which lead starts by at least a month, were at their highest level since June 2008.
The drop in starts followed an outsized gain in December and was confined to the Northeast and Midwest, suggesting winter weather likely contributed to the pullback.
"The fundamentals are there and the drivers are looking good," said Patrick Newport, an economist at IHS Global Insight in Lexington, Massachusetts. "We see more new construction this year. The only question is whether it will be in the multi-family or single-family segment."
Housing has shifted from being a headwind for the economy to being a pillar of support, although mortgage rates have crept higher in recent weeks, cooling loan demand.
Luxury homebuilder Toll Brothers on Wednesday reported disappointing quarterly results, hurt in part by lower selling prices, but other homebuilders have been able to take advantage of the recovering market.
A separate report from the Labor Department showed producer prices rose 0.2 percent last month as rebounding food costs offset declining gasoline prices. Wholesale prices had slipped 0.3 percent in December, and economists had expected them to rise 0.4 percent in January.
Food prices accounted for more than 75 percent of the rise in wholesale prices last month.
INFLATION PRESSURES MUTED
Away from the spike in food prices, the producer price report showed inflation pressures were generally muted.
In the 12 months through January, wholesale prices were up 1.4 percent and data on Thursday is expected to show consumer inflation below the U.S. central bank's goal of 2 percent.
"Inflationary pressures remain well contained," said Diane Swonk, chief economist at Mesirow Financial in Chicago. "The Federal Reserve would rather see inflation slightly higher in response to stronger economic conditions than benign because the recovery remains tepid."
In an effort to drive down borrowing costs and spur stronger growth, the Fed last year launched an open-ended bond buying program and said it would keep it up until it saw a substantial improvement in the outlook for the labor market.
But minutes of the U.S. central bank's Jan. 29-30 meeting showed a number of policymakers believed the Fed might have to slow or stop asset purchases before seeing an acceleration in job growth because of concerns over the costs.
U.S. stocks fell on the minutes, with the Standard & Poor's 500 index posting its biggest one day percentage decline since mid-November.
The dollar rose against a basket of currencies. Prices for U.S. Treasury debt ended higher.
Wholesale prices excluding volatile food and energy costs edged up 0.2 percent last month after gaining 0.1 percent in December. In the 12 months through January, those so-called core prices rose 1.8 percent, the smallest gain since February 2011.
A surge in the cost of fresh and dried vegetables pushed up food prices in January. Gasoline prices surprisingly recorded another substantial decline last month, even though prices at the pump have been rising almost every week this year.
The core PPI was lifted by a jump in the cost of drugs, while passenger car and light truck prices fell.