FILE PHOTO: Newly constructed single family homes are shown for sale in Encinitas, California, U.S., July 31, 2019. REUTERS/Mike Blake/File Photo

By Lucia Mutikani

WASHINGTON (Reuters) -Sales of new U.S. single-family homes surged to the highest level in more than 3-1/2 years in August, but that likely exaggerates the housing market's health, and a weakening labor market could limit the boost from falling mortgage rates.

The bigger-than-expected increase in sales last month reported by the Commerce Department on Wednesday was shrugged off by economists, who noted that new housing data was extremely volatile and subject to revisions. They also said the jump in sales was at odds with subdued homebuilder sentiment.

"There is no obvious driver. I expect that this spike in sales will be largely reversed in coming months," said Stephen Stanley, chief U.S. economist at Santander U.S. Capital Markets.

"One could potentially point to lower mortgage rates ... but the bigger fall has come in September. One might think that builders capitulated and cut their asking prices sharply, but the average price of new homes sold in August actually jumped versus July."

New home sales shot up 20.5% to a seasonally adjusted annualized rate of 800,000 units last month, the highest level since January 2022, the Commerce Department's Census Bureau said. The increase was the biggest since August 2022.

The sales pace for July was revised higher to a rate of 664,000 units from the previously reported pace of 652,000 units. Economists polled by Reuters had forecast new home sales, which make up about 14% of U.S. home sales, easing to a rate of 650,000 units. June's sales pace was also upgraded.

New home sales, which are counted at the signing of a contract, are volatile on a month-to-month basis and subject to big revisions. They soared 15.4% on a year-over-year basis in August. Monthly sales rocketed 72.2% in the Northeast, which accounts for a small share of new housing construction.

They jumped 24.7% in the densely populated South and raced 12.7% in the Midwest. Sales rose 5.6% in the West.

The housing market has been in a slump because of higher mortgage rates, with residential investment contracting in the first half of this year.

MORTGAGE RATES ARE FALLING

Mortgage rates declined as the Federal Reserve prepared to resume easing monetary policy. The U.S. central bank cut its benchmark overnight interest rate last week by 25 basis points to the 4.00%-4.25% target. The Fed projected a steady pace of reductions for the rest of 2025.

The rate on the popular 30-year mortgage dropped to an 11-month low of 6.26% last week, data from mortgage finance agency Freddie Mac showed. It has been edging lower since mid-July and is down from around 7.04% in mid-January.

But the labor market has softened, with nonfarm payrolls gains averaging only 29,000 jobs per month in the three months to August compared to 82,000 during the same period last year.

"Lower mortgage rates should provide some lift to new home sales activity this fall," said Ben Ayers, a senior economist at Nationwide. "But builders are preparing for softer sales activity over the next six months with fewer single-family home projects breaking ground and fewer permits authorized."

Data from the Mortgage Bankers Association on Wednesday suggested homeowners were taking advantage of declining borrowing costs to refinance. There was a modest increase in applications for loans to buy a home last week.

With sales rising over the past three months, new housing inventory dropped to 490,000 units, the lowest level since last December, from 497,000 in July. Supply had hovered at levels last seen in late 2007. Builders have been cutting prices and offering incentives to reduce inventory. The median new house price increased 1.9% to $413,500 in August from a year earlier.

Most of the homes sold last month cost less than $500,000.

At August's sales pace, it would take 7.4 months to clear the supply of new houses on the market, down from 9.0 months in July. Homes under construction accounted for the bulk of the inventory last month.

"If, as seems likely, new sales drop back again, then homebuilders likely will respond to this overhang by trimming prices," said Oliver Allen, senior economist at Pantheon Macroeconomics. "Another way in which homebuilders will try to clear inventory will be an even further pullback in new single-family construction projects in the coming months."

(Reporting by Lucia Mutikani; Editing by Andrea Ricci)