By Lucia Mutikani

WASHINGTON (Reuters) – U.S. housing starts fell more than expected in August likely as bad weather disrupted building activity in the South, but a solid increase in permits for single-family dwellings suggested demand for housing remained intact.

Tuesday’s weak housing report came as officials from the Federal Reserve were due to gather for a two-day meeting to assess the economy and deliberate on monetary policy.

It joined a stream of recent soft economic data such as retail sales, nonfarm payrolls and industrial production, which, together with low inflation are expected to encourage the U.S. central bank to leave interest rates unchanged on Wednesday.

Groundbreaking decreased 5.8 percent to a seasonally adjusted annual pace of 1.14 million units after two straight months of strong gains, the Commerce Department said.

Single-family housing starts in the South, which accounts for the bulk of home building, tumbled 13.1 percent to their lowest level since May 2015. Economists said flooding in Texas and Louisiana was probably behind the drop in starts last month.

“We believe that the slowdown in August starts likely owes to a temporary weather effect rather than a substantive shift in the underlying trend,” said Rob Martin, an economist at Barclays in New York. “Excluding the South, housing starts increased a robust 4.2 percent.”

Permits for future construction slipped 0.4 percent to a 1.14 million-unit rate last month as approvals for the volatile multi-family homes segment tumbled 7.2 percent to a 402,000 unit-rate. Permits for single-family homes, the largest segment of the market, surged 3.7 percent to a 737,000-unit pace.

Economists polled by Reuters had forecast housing starts falling to a 1.19 million-unit pace last month and building permits rising to a 1.17 million-unit rate.

U.S. financial markets were little moved by the data as investors awaited Wednesday’s outcome of the Fed’s meeting. The broader PHLX housing index, which includes builders, building products and mortgage companies, fell 0.76 percent.

STRONG HOUSING FUNDAMENTALS

Last month’s decline in starts was largely anticipated as groundbreaking activity has been running well ahead of permits approvals over the past several months, especially in the single-family housing segment.

The drop left starts just below their second-quarter average, suggesting little or no contribution from residential construction to economic growth in the third quarter.

Spending on home building was a small drag on output in the April-June period. Following the report, the Atlanta Fed trimmed its third-quarter gross domestic product estimate by one-tenth of a percentage point to a 2.9 percent annual rate. The economy grew at a 1.1 percent rate in the second quarter.

Demand for housing is being driven by a tightening labor market, which is lifting wages. A survey of homebuilders published on Monday showed confidence hitting an 11-month high in September, with builders bullish about current sales now and over the next six months, as well as prospective buyer traffic.

Housing market strength boosted Lennar Corp’s profits in the third quarter. Lennar, the second-largest U.S. homebuilder, said it sold 6,779 homes in the three months ended Aug. 31, up 7.3 percent from a year earlier, while its average sales price rose more than 3 percent.

“Conditions seem well aligned for strong new home building. Borrowing costs remain low, the inventory of homes for sale, both new and existing, are relatively low and failing to make meaningful progress,” said Kristin Reynolds, a U.S. economist at IHS Global Insight in Lexington, Massachusetts.

Groundbreaking on single-family homes dropped 6.0 percent to a 722,000-unit pace in August, the lowest level since last October. But with permits for the construction of single-family homes rising last month, single-family home building could rebound in the months ahead.

The single-family housing market is being supported by a dearth of previously owned homes available for sale.

Housing starts for the volatile multi-family segment fell 5.4 percent to a 420,000-unit pace. The multi-family segment of the market has been buoyed by strong demand for rental accommodation as some Americans shun homeownership in the aftermath of the housing market collapse.

(Reporting by Lucia Mutikani; Editing by Andrea Ricci)