WASHINGTON (Reuters) -U.S. homebuilder sentiment jumped to a six-month high in October amid hopes that declining mortgage rates would stimulate demand for housing and help reduce an inventory overhang that has hampered new housing construction.

The National Association of Home Builders/Wells Fargo Housing Market index increased five points to 37 this month, the highest reading since April. It, however, remained below the 50 breakeven point for the 18th straight month. Economists polled by Reuters had forecast the index edging up to 33.

Higher mortgage rates have dampened housing demand, resulting in a glut of unsold new homes on the market. Though mortgage rates have eased as the Federal Reserve resumed cutting interest rates, growing economic uncertainty amid a lackluster labor market is keeping prospective buyers on the sidelines.

"While recent declines for mortgage rates are an encouraging sign for affordability conditions, the market remains challenging," said NAHB chairman Buddy Hughes. "The housing market has some areas with firm demand, including ... ongoing solid conditions for the luxury market. However, most home buyers are still on the sidelines." 

The survey's measure of current sales conditions increased four points to 38 this month, while its gauge of future sales jumped nine points to 54. A measure of prospective buyer traffic posted a four-point gain to 25.

Builders continued to reduce house prices to lure buyers. Thirty-eight percent reported cutting prices. The average price reduction rose to 6%, the largest cut in a year, after averaging 5% for several months. The use of sales incentives was unchanged at 65%.

New housing inventory decreased in August after hovering for several months at levels last seen in late 2007. A shutdown of the government amid a standoff over funding has suspended the collection and publication of economic data. The NAHB estimated new single-family building permits rebounded in September after plunging in August to the lowest level in more than two years.

"Based on modeling of historical data, the October increase for the HMI suggests an approximate 3% increase for the September single-family permit data on a seasonally adjusted annual rate basis," said NAHB chief economist Robert Dietz.