Sales of previously owned U.S. homes unexpectedly fell last month, a decline economists and real estate agents pinned on delays in processing mortgage applications.

Existing home sales fell 2.2 percent to an annual rate of 5.66 million units in May, the National Association of Realtors said on Tuesday.

The drop was surprising given that pending home sales, which usually lead resales by a month or two, rose in April, and economists said they expected a pick-up in June.

Pending sales are measured at contract signing while existing sales are logged at contract closing.

The fact that pending home sales have been trending upward suggests that perhaps closings are taking longer than expected. Still-tight lending is slowing the approval process and this may also be slowing the flow of home sales that are closing, said Celia Chan, a senior director at Moody's Analytics in West Chester, Pennsylvania.

Weak home sales will contribute to a slowing in the economy's recovery from the worst recession since the 1930s that has already become evident in other data but few analysts are worried about the risk of a renewed downturn.

A government program that offered a tax credit to buyers who signed a contract by the end of April and who close by the end of June has helped drive pending home sales higher.

Now that April has come and gone, pending sales are expected to drop but existing home sales had been expected to move higher for a few more months.

The Realtors group warned that as many as 180,000 buyers might be unable to finalize their contracts by the end of this month because of delays in processing mortgages, and were at risk of losing the tax credit.

The U.S. Senate has been considering a proposal to extend the cut-off date to the end of September but that legislation has become mired in a debate over a separate measure.

WEAK HOUSING DEMAND

While many economists blamed processing delays, the data did fuel some worry that demand for housing might be weaker than previously thought.

Stocks on Wall Street fell on the data, with all three main indices <.DJI> <.SPX> <.IXIC> closing down more than 1 percent. The poor housing report and strong demand at a government auction for 2-year notes sparked a rally on the U.S. Treasury debt market. The U.S. dollar fell against the yen.

Government incentives and near-record-low mortgage rates have helped the housing market dig out of a three-year slump.

The report came as Federal Reserve policymakers gathered for a two-day meeting at which they were expected to extend their pledge to hold overnight interest rates ultra low for an extended period to aid the still fragile economic recovery.

The Fed -- the U.S. central bank -- is not seen lifting rates, currently near zero, until next year.

With the end of the tax credit, new home construction has dropped and government data on Wednesday is expected to show new home sales fell last month. Still, analysts believe a sustainable recovery has taken hold.

The tax credit shifted sales from one period to another. What matters for the housing recovery is that the economy has to create more jobs, said Patrick Newport, a U.S. economist at IHS Global Insight in Lexington, Massachusetts.

Sales will drop over the next couple of months and will start growing again on a sustained basis because the job market is improving.

Last month, foreclosed properties and short sales accounted for 31 percent of transactions, the Realtors group said, with first-time buyers representing 46 percent.

Cash sales made up a quarter of the transactions, well above the normal 10 percent level.

Despite the weak sales, the supply of previously owned homes on the market fell 3.4 percent to 3.89 million units. At May's sales pace, that represented a supply of 8.3 months, compared with April's 8.4 months.

The national median home price rose 2.7 percent from May last year to $179,600, the highest since July. Prices were up 4.2 percent from April.

Separately, the U.S. Federal Housing Finance Agency's home price index rose 0.8 percent in April after gaining 0.1 percent in March. Analysts said prices, which got a boost from the tax credit, were likely to move sideways in the months ahead.

An improving economic backdrop will likely limit sharp price declines, but the significant foreclosure pipeline is likely to limit broad-based price gains, said Peter Newland, an economist at Barclays Capital in New York.

(Editing by James Dalgleish)

Pennsylvania