NEW YORK (CNNMoney.com) -- The pace of new home sales showed an unexpected increase in May, as the latest reading of the real estate market's strength bucked rising mortgage rates and other signs of a cooling housing market

New homes sold at an annual pace of 1.23 million homes in the month, up 4.6 percent from the revised 1.18 million annual sales pace in April. Economists surveyed by Briefing.com had forecast that sales would slow to a 1.15 million rate in May.

The report showed a decline in new home prices in May when compared to April, though price measures were still above year-earlier price levels.

The median new home price fell 4.3 percent from April to $235,300, although that is still up 3.1 percent from May 2005. Median reflects the point at which half the homes sell for more and half sell for less.

The average home price slipped 2.6 percent to $294,300, the first time it has been below the $300,000 mark since December. It is still up 2.4 percent year-over-year.

Most housing readings this year have been showing signs of a slowing real estate market, as mortgage rates rise and prices soften from record highs.

Builders' confidence has fallen to its lowest level since April 1995, according to the latest member survey by the National Association of Home Builders (NAHB). The pace of permits issued for new homes fell in May to the lowest level seen since 2003, according to a separate Census Bureau report.

But the May new home sales report showed the strongest pace of sales since December, with the South - the region that accounts for about half of new home sales - seeing its best sales rate since October.

The lower prices could be one of the things supporting the higher-than-expected new home sales numbers, said David Seiders, the chief economist for the NAHB, who admitted he was surprised when the report showed an increase in sales.

"The only reason you would think they were up [is] the aggressiveness of the builders' sales techniques," he said. "They're using Realtors more, they're using incentives more. In our January survey, 18 percent said they were doing some level of price cutting. In June, that was up to 41 percent. A year ago they had to do hardly anything to sell. They just had to whisper in the woods that they had a house and the buyers would come running."

Phillip Neuhart, economist at Wachovia, said that the report Monday doesn't change his view that housing is going through a significant slowdown. He said that the new home sales reading is inflated by the fact it is based on when a sales contract is signed, not when the sale is closed.

"Builders are reporting a high-number of cancellations, so these numbers are inflated," said Neuhart. "We think the NAHB survey is the best indication of the home building market right now."

Neuhart said the fact that the supply of new homes on the market remains well above year-ago levels is a sign of softness. But he said the report confirms the belief that housing will cool off slowly, rather than that experience a sharp and sudden decline in both sales and prices.

"It reflects a housing slowdown, not a housing crash. That's what we've been expecting for sometime," he said.

Seiders agreed that the monthly report shouldn't convince anyone that there isn't an longer-term cooling trend.

"We're hardly convinced the housing slowdown is over," he said.

New home sales are just a fraction of the overall real estate market, but they are considered a better, more up-to-date leading indicator than sales of previously-owned homes.

The existing home sales reading looks at home closings, which generally takes place a month or two after a contract to buy the home is signed. So the May existing home sales report due Tuesday will be looking at demand for those homes in March in April.

While practice of counting new home sales at the time a contract is signed does pose the problem of an order being cancelled, it does at least give a more current look at the demand for new homes in the market.

The new home sales also give a look at the home-building industry, which has become an important engine driving U.S. economic activity. Economists and investors are watching all signs of economic activity for clues as to when the Federal Reserve might stop raising interest rates.

"If you are looking for housing to slam the brake on the economy's expansion, it's just not happening," said Robert Brusca, a New York economist who runs FAQ Economics.

Related: More on the housing market, and what it means for you and the economy