(Adds mortgage applications, analyst comments, updates markets)
* Housing starts fall 0.9% in June; May revised lower
* Single-family starts rise 3.5%; multi-family drop 9.2%
* Building permits drop 6.1%; single-family increase 0.4%
By Lucia Mutikani
WASHINGTON, July 17 (Reuters) - U.S. homebuilding fell for a second straight month in June and permits dropped to a two-year low, suggesting the housing market continued to struggle despite declining mortgage rates.
The report from the Commerce Department on Wednesday also showed housing completions at a six-month low and a modest increase in the number of homes under construction, indications that an inventory squeeze that has haunted the market could persist for a while. Weak housing and manufacturing are holding back the economy, offsetting strong consumer spending.
Land and labor shortages, as well as expensive building materials are making it difficult for builders to meet demand for housing, especially in the lower price segment of the market.
Mortgage rates have been decreasing since the Federal Reserve signaled it was pausing its interest rate raising campaign. Borrowing costs could drop further as the U.S. central bank is poised to cut rates this month for the first time in a decade to protect to economy from rising threats from Washington's trade war with Beijing, and slowing global growth.
"Residential housing construction is one of the leading indicators of a recession and while construction activity isn't dropping precipitously, housing is stuck in a rut," said Chris Rupkey, chief economist at MUFG in New York. "If the Fed thinks rate cuts are going to send housing construction up like a rocket, they better think again."
Housing starts decreased 0.9% to a seasonally adjusted annual rate of 1.253 million units last month as a rebound in the construction of single-family housing units was overshadowed by a plunge in multi-family homebuilding, the government said.
Data for May was revised slightly down to show homebuilding falling to a pace of 1.265 million units, instead of slipping to a rate of 1.269 million units as previously reported. Economists polled by Reuters had forecast housing starts dipping to a pace of 1.261 million units in June.
Single-family homebuilding, which accounts for the largest share of the housing market, increased 3.5% to a rate of 847,000 units in June, partially recouping some of May's sharp drop. Single-family housing starts fell in the Northeast, but rose in the Midwest, West and South.
Building permits tumbled 6.1% to a rate of 1.220 million units in June, the lowest level since May 2017. Permits have been weak this year, with much of the decline concentrated in the single-family housing segment.
The housing market hit a soft patch last year and has been a drag on economic growth for five straight quarters. Economists believe housing had no impact on GDP in the second quarter.
The Atlanta Fed is forecasting gross domestic product rising at a 1.6% annualized rate in the April-June quarter. The economy grew at a 3.1% pace in the first quarter. The government will publish its advance GDP growth estimate for the second quarter next Friday.
The PHLX housing index was lower, underperforming in a broadly weak U.S. stock market. The dollar was little changed against a basket of currencies, while U.S. Treasury prices rose.
"These prints are in line with our view of a slowing housing market that is likely to continue on a downward trajectory for the rest of this year, but with no significant risks of an immediate slump," said Igor Cesarec, an economist at Citigroup in New York. "We continue to expect residential investment to be either flat or provide a slight boost to GDP growth in the second half of the year."
The 30-year fixed mortgage rate has dropped to about 3.75% from a peak of 4.94% in November, according to data from mortgage finance agency Freddie Mac.
A survey on Tuesday showed confidence among homebuilders increased in July. Builders, however, complained "they continue to grapple with labor shortages, a dearth of buildable lots and rising construction costs that are making it increasingly challenging to build homes at affordable price points relative to buyer incomes."
Permits to build single-family homes rose 0.4% to a rate of 813,000 units in June. Despite the increase last month, permits continue to lag housing starts, which suggests single-family homebuilding could remain sluggish.
Starts for the volatile multi-family housing segment dropped 9.2% to a rate of 406,000 units last month. Permits for the construction of multi-family homes plunged 16.8% to a pace of 407,000 units. Permits for buildings with five units or more were the lowest since March 2016.
Housing completions fell 4.8% to 1.161 million units last month, the lowest level since December.
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 bridge the inventory gap. The stock of housing under construction increased 0.5% to 1.135 million units in June.
"A sluggish first half of 2019 indicates that builders have so far not been as willing or able to put up as many new homes as the strong economy and milder summer weather might otherwise suggest," said Matthew Speakman, economist at online real estate group Zillow.
(Reporting By Lucia Mutikani; Editing by Andrea Ricci)
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