By Leah Schnurr

NEW YORK (Reuters) - Sentiment among homebuilders surged in June, rising above a key milestone for the first time since the start of the housing crisis seven years ago in a vote of confidence for the sector's recovery.

At the same time, a separate report on Monday showed manufacturing growth in New York state picked back up but the improvement was undermined by weakness in new orders and employment that suggested activity in the sector remains sluggish.

The National Association of Home Builders/Wells Fargo Housing Market index surged to 52 in June from 44 in May, handily topping forecasts for 45. It was the biggest one-month gain since 2002.

Readings above 50 mean more builders view market conditions as favorable than poor. It was the first time the index has been above that dividing line since April 2006 and was its highest level since March of the same year.

Confidence among homebuilders has strengthened in the last year and a half, alongside a recovery in the broader housing sector. The index is 23 points higher than where it was in June of last year.

Rising prices, tighter inventory and improved sales have all helped the housing market get back on its feet. In the stock market, the data pushed the housing index <.hgx> up 2.3 percent, with homebuilders Toll Brothers , Pulte Group and Lennar all gaining more than 2 percent.</ .hgx>

Cheap mortgage rates have helped lure in buyers, with borrowing rates kept low by the Federal Reserve's bond-buying program. A recent spike in rates has raised concerns about the headwinds that might pose to the recovery, though mortgages still remain cheap by historical standards.

"It looks like home builder optimism has rebounded even with higher mortgage rates, which would weigh on demand," said Sam Bullard, senior economist at Wells Fargo Securities in Charlotte, North Carolina.

"The pent-up demand is there."

Investors are looking to the Fed's policy-setting meeting later in the week for insight into when the central bank may start to slow its $85 billion a month bond purchases.

Homebuilders felt even more optimistic for the coming months with the gauge of single-family sales expectations for the next six months accelerating to 61 from 52. The single-family home sales component rose to 56 from 48, while prospective buyer traffic climbed to 40 from 33.

Separately, the New York Fed's "Empire State" general business conditions index rose to 7.84 from minus 1.43 in May, topping expectations for zero. A reading above zero indicates expansion.

But many of the details of the report deteriorated, including gauges of new orders and employment that fell to their lowest levels in five months.

"Sentiment may be improving but actual output isn't improving," said Michelle Meyer, senior economist at Bank of America Merrill Lynch in New York.

"This report suggests manufacturing activity is sluggish and that we are seeing that in the U.S. and the rest of the world."

While the housing recovery has been gaining traction, manufacturing activity in contrast has softened, hurt by belt-tightening in Washington and less demand overseas.

The most recent look at the sector on a national basis from the Institute for Supply Management showed manufacturing contracted in May to a four-year low.

Monday's regional report poses the risk that ISM's index could fall even further below the 50 mark when the June report is released at the beginning of next month, said Amna Asaf, economist at Capital Economics.

The economy overall is thought to have hit a soft patch in the second quarter and growth is forecast to slow from the 2.4 percent pace seen in the first three months of the year

(Additional reporting by Richard Leong; Editing by Chizu Nomiyama)

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