Other data on Tuesday showed consumer confidence unexpectedly rose in July but spending fell in June for the first time in nearly a year as Americans saved more.

The S&P/Case-Shiller composite index of 20 metropolitan areas gained 0.9 percent in May from April on a seasonally adjusted basis, topping economists' expectations for a 0.5 percent gain.

The housing market, which collapsed during the 2007-2009 recession, has been a relative bright spot in the economy this year, although it remains hobbled by tight mortgage availability and on-going foreclosures.

"Real estate continues to show improvement off the bottom. That's one of the few encouraging signs we've seen," said Subodh Kumar, an investment strategist at Subodh Kumar & Associates in Toronto.

On a non-seasonally adjusted basis, prices fared even better, jumping 2.2 percent. Compared to a year ago, price declines moderated to slip 0.7 percent, the smallest drop since the last time year-over-year prices rose in September 2010.

Economists cautioned prices could weaken again once the traditionally strong spring and summer buying season is over.

"The most likely scenario is that home prices will zigzag over the coming months, rising during the selling season, and slipping in the fall," said Michelle Valverde, U.S. economist at IHS Global Insight.

Housing makes up a smaller share of the economy than before the recession and can provide only a limited lift to the broader recovery, which has hit a soft patch in the wake of the euro zone debt crisis and a struggling domestic labor market.

The Labor Department is scheduled to release its employment report for July on Friday, with non-farm payrolls expected to rise a modest 100,000, according to a Reuters poll.

Pressure is rising on the Federal Reserve to do more to help the sputtering U.S. economy as policymakers at the central bank start a two-day meeting on Tuesday.

No major policy change is expected to be announced on Wednesday although some economists think the Fed could push further into the future its conditional pledge to keep rates near zero through late 2014.

Reaction to the data was muted in financial markets as investors had their sights set on the Fed announcement on Wednesday.

FRUGAL CONSUMERS

After growing at a 1.5 percent rate last quarter, the third quarter could also grow below 2 percent unless there is a positive surprise, such as action by policymakers, said Anthony Chan, chief economist at Chase Wealth Management in New York.

Consumer spending, which makes up about 70 percent of U.S. economic activity, fell 0.1 percent in June after adjustment for rising prices, the Commerce Department said in a separate report.

"Consumers are afraid," said Matthew Lifson, an analyst at Cambridge Mercantile Group in Princeton, New Jersey. "This data suggests that the U.S. economy is stagnant overall and it's just muddling."

Before adjustment for inflation, spending was flat, just below forecasts for a 0.1 percent increase.

Frugal shoppers hit upscale leather goods maker Coach Inc as it reported another quarter of slowing growth in North America, hurt by the deals it needed to offer consumers.

Household income rose in June by 0.5 percent - the most in three months - although nervous consumers socked away extra cash by saving more.

With price-adjusted incomes rising in June and consumption falling, the saving rate for households rose to 4.4 percent, its highest level in a year.

Still, consumers' moods have not completely deteriorated and a separate gauge showed confidence unexpectedly rose in July as Americans were more optimistic about the short-term outlook than they were about their current situations.

The Conference Board said its index of consumer attitudes climbed to 65.9 from a upwardly revised 62.7 in June. Recent strength in the U.S. stock market likely boosted sentiment, economists said.

Despite the improvement, confidence remains well below levels before the financial crisis.

"Given the current economic environment - in particular the weak labor market - consumer confidence is not likely to gain any significant momentum in the coming months," Lynn Franco, director of The Conference Board Consumer Research Center, said in a statement.

In the manufacturing sector, the pace of business activity in the U.S. Midwest rose in July, as somewhat stronger new orders offset a weakening labor environment.

The Institute for Supply Management-Chicago business barometer rose to 53.7 from 52.9 in June. The report comes a day ahead of two larger national manufacturing reports.

(Additional reporting by Lucia Mutikani in Washington and Gertrude Chavez-Dreyfuss, and Ryan Vlastelica in New York; Editing by Neil Stempleman)

• A Permanent Economic Emergency