WASHINGTON (Reuters) - U.S. housing starts fell more than expected in March and permits for future home construction hit a one-year low, suggesting some cooling in the housing market in line with signs of a sharp slowdown in economic growth in the first quarter.

Homes are seen for sale in the southwest area of Portland, Oregon March 20, 2014. REUTERS/Steve Dipaola

Tuesday’s report from the Commerce Department continued the recent run of weak data that has cast a pall on the economy’s prospects. Economists say the fragile economy, combined with tepid inflation vindicated the Federal Reserve’s cautious approach to raising interest rates.

“It’s not just American consumers stepping back a bit this year, homebuilders also lost steam,” said Sal Guatieri, a senior economist at BMO Capital Markets in Toronto. “This means the two key drivers of the expansion have lost their pep, which explains why the Fed will probably lift rates, at most, a couple of times in 2016.”

Groundbreaking decreased 8.8 percent to a seasonally adjusted annual pace of 1.09 million units, the lowest level since October, the Commerce Department said. Economists polled by Reuters had forecast housing starts slipping to a 1.17 million-unit pace last month.

Last month’s drop in starts pointed to a moderation in housing market activity and mirrors other reports on business spending, industrial production, trade, inventory investment and retail sales that have suggested economic growth stalled in the first quarter.

The economy has been slammed by a strong dollar and weak global demand, which have weighed on exports. Lower oil prices are also a drag as they have undercut profits of energy firms, prompting them to sharply curtail spending on capital projects.

First-quarter gross domestic product growth estimates are currently as low as a 0.2 percent annualized rate. The economy grew at a 1.4 percent rate in the fourth quarter.

The PHLX housing index .HGX was down slightly, underperforming a broadly higher stock market that was buoyed by rising oil prices. Shares in the nation's largest homebuilder D.R. Horton Inc DHI.N were down 0.95 percent andLennar Corp LEN.N slipped 0.84 percent.

The dollar fell against a basket of currencies and prices for U.S. government debt were weak.

STRONG FUNDAMENTALS

The Fed’s policy-setting committee meets on April 26-27. Market-based measures of expectations for Fed policy have priced out an interest rate hike in the first half of the year, according to CME Group’s FedWatch.

The Fed lifted its benchmark overnight interest rate in December for the first time in nearly a decade and policymakers recently forecast only two more rate hikes this year.

Despite the slump in groundbreaking activity last month, housing market fundamentals remain strong against the backdrop of a buoyant labor market, which is increasing employment opportunities for young adults, and in turn boosting household formation.

Single-family starts, the largest segment of the market, tumbled 9.2 percent to a 764,000-unit pace in March, the lowest since October, after touching a more than eight-year high in February. They fell in all four regions last month, sliding 4.9 percent in the South, where most home building takes place.

Groundbreaking on multi-family housing projects declined 7.9 percent to a 325,000-unit pace. Starts for buildings with five units and more fell to their lowest level in a year.

“There is still a lot of supply being built, but industry reports finding rental vacancy rates coming off the lows and rent gains slowing appear to be leading builders to pull back,” said Ted Wieseman, an economist at Morgan Stanley in New York.

Building permits dropped 7.7 percent to a 1.09 million-unit

rate last month, the lowest level since March last year.

Permits for the construction of single-family homes decreased 1.2 percent in March after scaling a more than eight-year high in February. Multi-family building permits plunged 18.6 percent, with approvals for buildings with five units or more falling to their lowest level since August 2013.