Sales of new homes in the US plunged to a 12-year low last month, signalling that the flagging housing market will remain a drag on the US economy well into 2008.

News of the bigger-than-expected decline reversed Wall Street's buoyant start, sending the S&P, the Nasdaq Composite Index and the Dow Jones Industrial Average into negative territory.

Homebuilder stocks suffered a sharp sell-off, with DR Horton down 3.4 per cent and KH Home down 4.1 per cent. By mid-afternoon, stocks were flat and the dollar was down 1.9 per cent for the week, on pace for its worst weekly performance since November 2006.

The sale of single-family homes fell 9 per cent to an adjusted rate of 647,000 last month, according to the US Commerce Department. Forecasters had predicted a decline to 720,000 units. New home sales fell 34 per cent from last year, representing the steepest year-on-year drop since 1991.

The inventory of homes for sale rose to 9.3 in November, from 8.8 in the previous month. The median price of homes fell 0.4 per cent in November from the same period last year.

"The high level of inventories will put downward pressure on prices," said Gary Bigg, an associate economist at Bank of America. "The headwinds of high inventories and tighter credit availability also suggest that construction activity will decline through much of 2008."

Shares in the homebuilder sector have lost 60 per cent of their value this year as house prices have slumped and unsold home inventories have risen.

Morgan Stanley predicted that single-family new home sales will have to drop an extra 30 per cent to 35 per cent to bring inventories back into balance in 2008.

The "miserably weak" report showed it was too soon to talk about a stabilisation in the housing market, which was undergoing a "very significant adjustment", said Conrad DeQuadros, senior economist at Bear Stearns.

"It is difficult to say that the adjustment has run its course. We've probably got several months of weak housing data in front of us," said Mr DeQuadros. But he said the data contrasted positive news in the manufacturing industry this week.

"This is the tale of two economies. The rest of the economy is showing moderate growth. What that means for the Fed, is we are probably going to see another rate cut in January. It might be the last one for the year," Mr DeQuadros said.