(Adds Fed interest rate cut, updates markets)
* Housing starts increase 12.3% in August
* Single-family starts rise 4.4%; multi-family up 32.8%
* Building permits gain 7.7%; single-family up 4.5%
By Lucia Mutikani
WASHINGTON, Sept 18 (Reuters) - U.S. homebuilding surged to more than a 12-year high in August as both single- and multi-family housing construction accelerated, suggesting that lower mortgage rates were finally providing a boost to the struggling housing market.
The report from the Commerce Department on Wednesday also showed permits for future home construction rose to levels last seen in 2007. Housing and manufacturing have been the weak spots in the economy, which is now in its 11th year of expansion, the longest in history.
The jump in homebuilding activity last month added to strong retail sales data in suggesting the economy continues to grow moderately and is probably not flirting with a recession as has been flagged by financial markets. A year-long trade war between the United States and China has dimmed the economic outlook.
The Federal Reserve cut interest rates by another 25 basis points on Wednesday to blunt the hit on the economy from the trade tensions, but offered mixed signals on the next move. The U.S. central bank said "economic activity has been rising at a moderate rate." The Fed lowered borrowing costs in July for the first time since 2008.
"A prolonged period of lower mortgage rates has perhaps finally encouraged prospective homebuyers to get off the sidelines," said John Pataky, executive vice president at TIAA Bank in Jacksonville, Florida. "I'd like to see a couple more months of data like this before I'm convinced the market's fortunes have really changed."
Housing starts jumped 12.3% to a seasonally adjusted annual rate of 1.364 million units last month, the highest level since June 2007, the government said. Data for July was revised up to show homebuilding falling to a pace of 1.215 million units, instead of decreasing at a rate of 1.191 million units as previously reported.
Economists polled by Reuters had forecast housing starts would advance to a pace of 1.250 million units in August. Building permits increased 7.7% to a rate of 1.419 million units in August, the highest level since May 2007. Housing starts rose 6.6% on a year-on-year basis in August.
The housing market, the most sensitive sector to interest rates, had until now shown few signs of benefiting from the Fed's monetary policy easing, which has pushed down mortgage rates from last year's multi-year highs. Builders had blamed the lackluster performance on land and labor shortages.
A survey on Tuesday showed confidence among homebuilders rose in September, with builders reporting solid demand for homes. But builders said scarce building lots and labor remained a challenge and also noted that trade tensions, which have undercut manufacturing, were "holding back home construction in some parts of the nation."
The 30-year fixed mortgage rate has dropped more than 130 basis points to an average of 3.56%, according to data from mortgage finance agency Freddie Mac.
Firmer demand for housing was underscored by a separate report on Wednesday from the Mortgage Bankers Association showing applications for loans to purchase a home increased for a third straight week last week.
The dollar dollar rose marginally against a basket of currencies as investors focused on the Fed's mixed signals on the future course of monetary policy. U.S. Treasury prices trimmed gains and stocks on Wall Street extended losses.
Stock market sentiment was also hurt by package delivery company FedEx's warning that full-year earnings would miss analysts' estimates because of the U.S.-China trade war and the fallout from its split with customer-turned-competitor Amazon.com Inc.
August's robust homebuilding performance raised hopes that residential investment would rebound in the third quarter after contracting for six straight quarters, the longest such stretch since the 2007-2009 recession.
The Atlanta Fed lifted its third-quarter gross domestic product estimate by one-tenth of a percentage point to a 1.9% annualized rate. The economy grew at a 2.0% rate in the April-June quarter, decelerating from the first quarter's 3.1% pace.
Single-family homebuilding, which accounts for the largest share of the housing market, increased 4.4% to a rate of 919,000 units in August, the highest level since January. Single-family housing starts increased in the West, Midwest and the populous South, but fell in the Northeast.
Permits to build single-family homes vaulted 4.5% to a rate of 866,000 units last month, the highest since July 2018. Permits, however, continued to lag housing starts, suggesting limited scope for a strong rise in single-family homebuilding in the coming months.
Starts for the volatile multi-family housing segment soared 32.8% to a rate of 445,000 units in August, reversing the prior two months' declines. Though rental inflation has slowed in recent months, economists do not expect the trend to continue as rental vacancy rates remain low.
Permits for the construction of multi-family homes increased 13.3% to a rate of 553,000 units last month.
Despite the surge in both starts and permits in August, housing shortages will likely persist and keep prices elevated.
Housing completions rose 2.4% to 1.294 million units last month. Realtors estimate that housing starts and completion rates need to be in a range of 1.5 million to 1.6 million units per month to close the inventory gap. The stock of housing under construction climbed 0.3% to 1.144 million units in August.
"The stock of new homes priced under $300,000, which is what half of new homebuyers need before they can afford a purchase, continues to be low," said Robert Frick, corporate economist at Navy Federal Credit Union in Vienna, Virginia. "And the pace of home building remains significantly below historical averages." (Reporting by Lucia Mutikani Editing by Paul Simao)