By Lucia Mutikani

WASHINGTON (Reuters) -U.S. homebuilding plunged to more than a three year-low in August as a resurgence in mortgage rates weighed on demand for housing, but a surge in permits suggested new construction remained supported by a dearth of homes on the market.

The decline in housing starts reported by the Commerce Department on Tuesday was the largest in a year and occurred across the board, suggesting that an anticipated housing market recovery was still far off. The report followed on the heels of news on Monday that homebuilders' confidence slumped to a five-month low in September, with more builders reporting they were cutting prices and offering other incentives to lure buyers.

The housing market has been the sector hardest hit by the Federal Reserve's aggressive monetary policy tightening. The U.S. central bank is expected to leave interest rates unchanged on Wednesday.

"Housing starts are likely to rebound in September, but we expect the pace of starts to decline in the fourth quarter as the economy and job growth slow," said Nancy Vanden Houten, lead U.S. economist at Oxford Economics in New York. "High mortgage rates will also weigh on demand and dampen construction, but we think a need for supply and homebuilder incentives will cushion the downside for single-family starts."

Housing starts tumbled 11.3% to a seasonally adjusted annual rate of 1.283 million units last month, the lowest level since June 2020. Data for July was revised lower to show starts accelerating to a rate of 1.447 million units instead of the previously reported 1.452 million units.

Economists polled by Reuters had forecast starts would slip to a rate of 1.440 million units. Single-family housing starts, which account for the bulk of homebuilding, dropped 4.3% to a rate of 941,000 units last month. Single-family homebuilding dropped in the Northeast, West and Midwest, but rose in the densely populated South.

HIGHER MORTGAGE RATES

Demand for new construction has been boosted by an acute shortage of previously owned homes on the market, with homebuilding rising for much of this year and breathing life into the housing market. But a recent surge in mortgage rates, in tandem with higher U.S. Treasury yields, is pushing buyers to the sidelines. The average rate on the popular 30-year fixed mortgage is hovering around 7.18%, the highest since March 2002, according to data from mortgage finance agency Freddie Mac.

The resurgence in mortgage rates is weighing on sentiment among homebuilders. A survey on Monday showed the National Association of Home Builders/Wells Fargo Housing Market Index dropped below the break-even mark of 50 in September for the first time in five months. The survey's measure of prospective buyers tumbled to the lowest level since February.

Starts for housing projects with five units or more plunged 26.3% to a rate of 334,000 units in August. Multi-family housing construction appears to have peaked in April 2022, when it was fueled by demand for rental accommodation as higher mortgage rates priced out potential home buyers.

Tighter financial conditions, which are limiting credit access for builders, as well as a huge stock of multi-family housing under construction are slowing activity.

Permits for future homebuilding jumped 6.9% to a rate of 1.543 million units, the highest since October 2022. They were boosted by a 14.8% surge in multi-family housing permits to a rate of 535,000 units. Single-family housing permits rose 2.0% to a rate of 949,000 units, the highest since May 2022.

Residential investment has contracted for nine straight quarters, the longest such stretch since the housing bubble burst, triggering the 2008 global financial crisis and the Great Recession.