U.S. building permits near eight-year high; starts pull back

(Updates with Fed starting meeting, market prices)

* Housing starts fall 11.1 percent in May; April revised up

* Building permits jump 11.8 percent, second monthly gain

* Single-family permits highest since December

By Lucia Mutikani

WASHINGTON, June 16 (Reuters) - U.S. permits for future home construction surged to a near eight-year high in May, suggesting a building up of momentum in housing and the broader economy after a dismal performance at the start of the year.

While housing starts fell last month, that followed a robust gain in April and groundbreaking remained at levels consistent with a strengthening housing market.

Housing's improving fortunes, marked by rising home prices and sales, are likely to be acknowledged by Federal Reserve officials, who started a two-day policy meeting on Tuesday.

Policymakers have repeatedly singled out housing as one of the weak spots in the economy. The U.S. central bank is expected to raise interest rates later this year. It has kept its short-term lending rate near zero since December 2008.

"Residential construction has been the laggard in this recovery and the moon shot surge in new permits today means the final piece of the recovery puzzle is now falling into place," said Chris Rupkey, chief financial economist at MUFG Union Bank in New York.

Building permits jumped 11.8 percent to a seasonally adjusted annual pace of 1.28 million units, the highest since August 2007, the Commerce Department said. It was the second straight month of increase. Permits have been above a 1 million-unit pace since July.

Groundbreaking dropped 11.1 percent to a 1.04 million-unit rate. Though that partially reversed the prior month's large gain, April starts were revised up to a 1.17 million-unit rate, the highest since November 2007.

Economists had forecast both building permits and housing starts falling to a 1.10 million-unit pace last month. April starts were previously reported to have increased to a 1.14 million-unit rate.

The Commerce Department report came on the heels of solid data on retail sales, consumer confidence and employment that have suggested the economy was rebounding from the first-quarter's soft patch, when gross domestic product contracted.

Growth estimates for the second quarter are currently as high as a 3.3 percent annual rate.

The dollar rose against a basket of currencies and U.S. Treasury debt prices were higher on safe-haven bids amid worries Greece could default on its debt.

U.S. stocks were trading higher after a two-day losing streak. But the S&P homebuilding index fell 0.28 percent. D.R. Horton Inc, the largest U.S. homebuilder, slipped 0.22 percent. Lennar Corp (NYSE: LEN - news) , the nation's second-largest homebuilder, fell 0.48 percent.

BUILDERS UPBEAT

Home building has regained ground lost during a harsh winter and there are signs activity will accelerate this year as tightening labor market conditions spur stronger wage gains and encourage young adults to move from their parents' basements.

A survey on Monday showed confidence among builders vaulting to a nine-month high in June, with measures of both current sales and buyer traffic increasing solidly.

Economists anticipate that the housing market will strengthen enough to take up some of the slack from the struggling manufacturing sector and support economic growth.

"With the trade deficit no longer widening, business investment improving and households buying vehicles like crazy, the GDP number could come in a lot better than most expect," said Joel Naroff, chief economist at Naroff Economic Advisors in Holland, Pennsylvania.

"Investors need to recognize that while a rate hike tomorrow looks to be off the table, the economy is already strong enough to support one at any meeting in the future."

Single-family building permits, which account for the largest share of the market, increased 2.6 percent to their highest level since December. Building permits for the volatile multifamily segment soared 24.9 percent.

Permits for buildings with five units or more increased to their highest level since January 1990. The multifamily sector is being driven by demand for rental accommodation as more people move away from homeownership.

Permits in the Northeast vaulted to their highest level since March 1987 and were at a near one-year high in the Midwest. They fell, however, in the South and West.

Groundbreaking for single-family homes dropped 5.4 percent to a 680,000 unit pace. Multifamily starts tumbled 20.2 percent to a 356,000 unit rate.

Groundbreaking fell in all four regions, declining a steep 26.5 percent in the Northeast after April's spectacular gains. Starts in the South, where most of the home building takes place, dropped 5.0 percent.

(Reporting By Lucia Mutikani; Editing by Meredith Mazzilli and Andrea Ricci)