WASHINGTON (Reuters) - Contracts to buy previously owned U.S. homes fell for a second straight month in April amid a supply squeeze, but the housing market recovery remains supported by a strong labor market.

A U.S. flag decorates a for-sale sign at a home in the Capitol Hill neighborhood of Washington, August 21, 2012. REUTERS/Jonathan Ernst

The National Association of Realtors said on Wednesday its Pending Home Sales Index, based on contracts signed last month, dropped 1.3 percent to 109.8. Contracts fell in the Northeast, Midwest and South, but surged 5.8 percent in the West.

Coming on the heels of recent data showing a drop in home building and sales of both new and previously owned homes, the decrease in contracts suggests a moderation in housing activity. Still, housing is expected to contribute to gross domestic product this year.

“We think that the housing recovery will continue over time based on favorable fundamentals in the market, but we have seen some weakening in a number of home sale measures lately,” said Daniel Silver, an economist at JPMorgan in New York.

“For now, we think the recent softening in sales is a pause in a broader upward trend.”

Economists had forecast pending home sales, which become sales after a month or two, rising 0.5 percent last month. They fell 3.3 percent from a year ago. That is the first year-on-year drop since last December and the largest since June 2014.

The PHLX housing index .HGX was little changed amid a broadly weaker stock market. The dollar fell against a basket of currencies, while U.S. Treasury prices were trading higher.

Demand for housing is being driven by a tight labor market, marked by a 4.4 percent unemployment rate, which is generating wage increases and boosting employment opportunities for young Americans. The housing market remains supported by historically low mortgage rates, with the 30-year fixed mortgage rate averaging 3.95 percent, the lowest level since last November.

Sales activity, however, remains constrained by tight inventories, which are driving up home prices. Housing inventory has dropped for 23 straight months on a year-on-year basis.

Home resales declined 2.3 percent in April and could decrease in May as another report on Wednesday showed applications for loans to buy a home fell for a third straight week last week.

“The large declines in the Northeast and Midwest suggest seasonal factors exaggerated the recent slide in pending home sales,” said Mark Vitner, a senior economist at Wells Fargo Securities in Charlotte, North Carolina. “Mortgage applications add a note of caution, however.”

A third report showed manufacturing activity in the Midwest region accelerated to a 2-1/2-year high in May. The Chicago Purchasing Management Index rose to a reading of 59.4 this month, the highest level since November 2014, from 58.3 in April.