U.S. housing starts unexpectedly rose 0.6 percent in August to their highest level in five months as low mortgage rates encouraged construction, but permits fell more than anticipated, a government report showed on Tuesday.

Housing starts climbed to a seasonally adjusted annual rate of 2.000 million units from an upwardly revised 1.988 million in July, the Commerce Department said. Analysts polled by Reuters had expected starts to ease to a 1.935 million pace.

"It suggests that the housing market is still quite healthy despite the increase in mortgage rates earlier this year," said Gary Thayer, chief economist at A.G. Edwards & Sons.

Separately, reports showed U.S. chain store sales in early September rose from a year ago.

Analysts said the housing starts increase was a pleasant surprise because it counts a period just before recent destructive hurricanes in the South, which are likely to boost housing construction.

The dollar rose modestly against other currencies on the data, which could be indicative of a stronger economy and may portend higher interest rates. Market watchers were waiting for further cues from a Federal Reserve statement on the economy due later in the day.

U.S. stocks were nearly unchanged by midday, with the Dow Jones industrial average up 7 points at 10,212.

U.S. Treasuries prices slipped as traders turned cautious ahead of what is expected to be the Federal Reserve's third interest rate boost of the year.

The benchmark 10-year note (US10YT=RR) price eased 5/32 on the housing data, while yields edged up to 4.08 percent after registering a five-month closing low of 4.06 percent on Monday.

Single-family housing starts rose to a 1.667 million unit rate, the strongest showing since November 2003.

All housing starts in the Northeast rose to 196,000 units, their highest level in more than 14 years, when builders broker ground at a 216,000 annual pace in February 1990.

Permits, a sign of builder confidence, slid 5.5 percent to 1.952 million units from a 2.066 million pace in July. Market watchers had forecast permits to ease to a 1.980 million unit pace.

Housing starts climbed in every region except the West, where they slipped by 4.7 percent. Starts rose 1 percent in the South, the region of greatest activity, by 4.8 percent in the Midwest, and by 6.5 percent in the Northeast.

Mortgage interest rates, which have hovered not far above historical lows, have fueled a multiyear housing boom in the United States, helping support the U.S. economy's recovery from recession despite uncertain business investment.

Analysts are watching very carefully for any signs that rising house prices in many metropolitan areas are poised for decline.

New applications for U.S. home loans fell in early September from a four-month high even as 30-year mortgage rates declined to their lowest level since late March, an industry group said last week.

In reports on consumer activity, the ICSC-UBS Weekly Chain Store Sales Snapshot said major discount, department and chain store sales fell 1.1 percent last week from the previous week, but were up 3.5 percent from the same week a year ago.

Also, Redbook Research, an independent company, said sales at major retailers increased 2.6 percent last week on a year-over-year basis

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