The decline in construction demand could be a reflection of the delayed impact of the withdrawal of the extra first home owners grant and the cumulative impact of the run of interest rate increases from last October, according to AI Group director public policy Peter Burn.

Since last October, the Reserve Bank of Australia has lifted interest rates significantly, with six rate-rises in its last nine meetings to the current 4.5 per cent level.

Amid continuous crushing credit conditions and reduced demand, as well as a decline in new orders, employment and deliveries, and a dip in home building, activity in the construction sector narrowed in June for the first time in three months as the industry was weaned off government stimulus.

Slumping 6.8 points to 46.4, the Australian Industry Group/Housing Industry Association Performance of Construction Index is below the 50 level that divides expansion from contraction, according to a survey.

Across construction, the house building activity sub-index fell 13.9 points after ten consecutive months of expansion, while the apartment building sub-index shrank for the second month in a row.

Engineering construction, on the other hand, returned to positive territory in June, while commercial construction also increased.

"The sharp fall in recorded activity in the house building sub-sector comes after almost a year of expansion," said Mr Burn.

"The housing outcome together with the continuing weakness of the apartment sector reinforces other signs of flat household spending."

HIA chief economist Harley Dale said the sub 50 reading for the detached house sector emphasised the possibility that the stimulus-driven new home building recovery would not turn into sustainable growth in 2011.

"As the impacts from past stimulus measures wane, higher interest rates and significant supply side obstacles are combining to stop the residential recovery in its tracks at a time when non-residential building remains very weak once stimulus to this sector is taken into account.

"Perennial obstacles to boosting Australia's new housing stock, including lack of readily available affordable land, are this cycle being exacerbated by the overarching problem of a dire lack of available credit."

"The restriction of credit is evident across low, medium, and high density residential developments, with no account being taken of the differences in structure within."