US home sales are up, home building is up. Can home prices be far behind?

That depends on how many homes come on the market as owners deal with defaults, pay cuts and job losses. This "shadow inventory" will create new downward pressure on home prices.

For now, the data suggest home prices are flattening out.

The S&P/Case-Shiller 20-City home price index for June was down 15.4 per cent year-over-year, better than the 16.4 per cent fall expected by economists.

The index increased 1.5 per cent from its May level, which was up 0.5 per cent from April, the first back-to-back increases since the summer of 2006. Stabilised home prices are considered imperative for financial markets to mend totally and consumer wealth to stop falling.

But it's "too soon to call this a turning point," cautioned economist and the index's co-developer, Robert Shiller, during an S&P teleconference on home prices.

One big reason is the millions of owners who want to sell their homes but are holding back because of low prices. Signs of a bottoming out may push them to enter the market.

And if inventories keep creeping up, house hunters will have little incentive to meet asking prices or create bidding wars. Buyers have to perceive a limited supply of homes before price increases can gain traction.

Clearly, demand has picked up since the spring, helped by greater affordability and the tax credit for first-time buyers. Existing home sales rose a strong 7.2 per cent in July.

But inventory increased 7.3 per cent, to 4.09 million, and the supply of homes for sales remained at 9.4 months. While that's down from last winter, it is well above the normal supply of about five or six months.

And supply could keep growing.

"There appears to be a large 'shadow' inventory of homes available for sale," says Steven Wood of Insight Economics, the result of hesitant homeowners and financial institutions temporarily holding foreclosed homes off the market.

Indeed, foreclosed homes represent the main inventory problem. The Mortgage Bankers Association reports that 720,000 began the foreclosure process in the second quarter. And Barclays Capital forecasts the number will peak at 1.15 million in mid-2010.

Foreclosures will increase as long as the unemployment rate rises. Cash-strapped homeowners are missing mortgage payments, leading the way to greater delinquencies and foreclosures.

The urge to default on a mortgage may be greatest at the intersection of two unfortunate groups: the 14.5 million unemployed and the 15.2 million homeowners whose mortgages are worth more than their homes.

"In the past if you had equity in your house but no job, you sold the house and moved to find a new job," says Mark Fleming of mortgage-data tracker First American CoreLogic.

"But we have a new feedback loop right now: can't sell house, can't move to find a job."

As a result, says Mr Fleming, people may feel they have little choice but to default to get out from under the mortgage.

Those foreclosures will increase housing inventory later on, a negative for the price outlook.