Residential construction activity picked up in December, helping to make all of 2003 the best year for home builders in a quarter-century and underscoring the critical role the sector played in the economy's resurgence.

The Commerce Department (search) reported Wednesday that housing construction increased by 1.7 percent last month from November — ending 2003 on a high note. For all of last year, the number of housing units that builders broke ground on totaled 1.85 million, up from 1.70 million in 2002.

The total for 2003 marked the strongest performance since 1978, when housing construction came to 2.02 million.

December's performance, meanwhile, was a lot better than analysts expected. They were forecasting a nearly 6 percent drop in activity.

The housing market — powered by low interest rates — was one of the main forces supporting the economy last year. The sector's strength contributed to the blistering 8.2 percent growth rate in the economy in the third quarter of 2003 — the best performance in nearly two decades.

Economists believe the housing market probably will slow a bit this year — but still register healthy activity — based on expectations that long-term mortgage rates (search) probably will creep higher later this year.

Rates on benchmark 30-year mortgages sank to a four-decade low of 5.21 percent in the middle of June and have bounced around since then. Last week, rates on these mortgages stood at 5.66 percent, a six-month low.

With signs that the economy is gaining ground, analysts expect Federal Reserve (search) policy-makers to hold short-term interest rates at 1 percent, a 45-year low, when they meet next week.

Some economists believe rates will stay where they are for the rest of this year and into 2005 because inflation is low and the labor markets still need time to heal. Others, however, believe the Fed could start nudging rates up later this year if the economy goes gangbusters.

In another encouraging sign, housing permits — a good sign of current demand — increased by 3.3 percent in December from the previous month. For all of 2003, permits totaled 1.86 million units, the highest since 1972 and up from 1.75 million in 2002.

Economists believe the economy slowed to a rate of around 4 percent to 5 percent in the fourth quarter of 2003 as the stimulative impact of the President Bush's third round of tax cuts and a refinancing frenzy faded. Bush in his State of the Union address on Tuesday evening called on Congress to make the tax cuts permanent in an effort to keep the economic recovery lasting.