U.S. construction spending rebounded strongly to hit its highest level in more than 5-1/2 years in July as private construction increased and state and local government outlays surged, in a further sign of vigor in the economy.

Construction spending increased 1.8 percent to an annual rate of $981.31 billion, the highest level since December 2008, the Commerce Department said on Tuesday.

July's percentage increase was the largest since May 2012 and reflected gains across all categories, with the exception of federal government.

It followed June's revised 0.9 percent decline.

Economists polled by Reuters had forecast construction spending increasing 1.0 percent after a previously reported 1.8 percent drop in June.

Construction spending in July was buoyed by a 3.4 percent jump in state and local government projects, which lifted outlays to their highest level since June 2012. The increase in state and local government outlays, which was the largest since April 2013, offset a 1.1 percent drop in spending by the federal government on construction projects.

Private construction, the largest portion of construction spending, advanced 1.4 percent to its highest level since November 2008. Private residential construction spending gained 0.7 percent as housing starts rebounded.

The housing market recovery is back on track after stagnating from the second half of 2013 in the wake of a spike in mortgage rates and higher home prices amid a stock shortage.

Part of the increase in private residential construction spending reflected home improvements.

Investment in private nonresidential structures such as factories and gas pipelines jumped 2.1 percent in July to its highest level in five years.