WASHINGTON (Reuters) - U.S. construction spending unexpectedly fell in August amid a sharp drop in outlays on single-family housing projects, but declining borrowing costs could stimulate activity in the months ahead.

The Commerce Department's Census Bureau said on Tuesday construction spending dipped 0.1% after a downwardly revised 0.5% drop in July. Economists polled by Reuters had forecast construction spending would edge up 0.1% after a previously reported 0.3% decrease.

Construction spending increased 4.1% on a year-on-year basis in August.

Spending on private construction projects slipped 0.2% in August after declining 0.7% in July. Investment in residential construction fell 0.3% with outlays on new single-family projects slumping 1.5%.

The rising supply of new homes on the market is discouraging builders from breaking ground on new housing projects.

That, together with buyers holding out for lower mortgage rates could, in the near term, limit the boost from declining borrowing costs. The Federal Reserve last month cut interest rates for the first time in four years. The U.S. central bank is expected to reduce rates again in November and December.

Mortgage rates are at two-year lows, while the inventory of new homes is at levels last seen in early 2008.

Spending on multi-family housing units fell 0.4%. But spending on home renovations increased.

Investment in private non-residential structures like offices and factories dipped 0.1%.

Spending on public construction projects advanced 0.3% after rising 0.5% in July. State and local government spending rose 0.3% and outlays on federal government projects increased 0.5%.

(Reporting by Lucia Mutikani)