Homebuilder stocks rallied Monday after new-home sales data came in higher than expected for May.

Sales of new one-family houses were at a seasonally adjusted annual rate of 1.23 million, up 4.6% above the revised April rate of 1.18 million, but down 5.9% from May 2005, the Commerce Department said. Economists expected 1.15 million annualized starts last month.

"Obviously it was a good month in terms of total sales," says Brian Bethune, U.S. economist with Global Insight. He attributes the good sales to price cuts by homebuilders looking to move inventory, along with some growing demand from people looking to buy before mortgage rates shoot up.

"What is happening is the homebuilders themselves are making sure that they are not going to be caught necessarily with excess inventory," Bethune said. "So what they're doing is offering various kinds of incentives, from short-term incentives to other types of incentives to work through their inventories at a period where the housing market is at a greater risk."

Inventory stood at 556,000 homes at the end of the month, which represents a supply of 5.5 months at the current sales rate, lower than the recent peak of 6.4 months in February. However, the overall inventory level is up from February's total of 538,000.

Whether or not the current sales pace can last is one major question going forward. "That is what is keeping the homebuilders up at night," Bethune says.

The median sales price of new houses sold in May was $235,300, up from $228,300 a year earlier.

Homebuilders rallied on the report. In early trading Monday,

Centex

(CTX)

rose 4.5% to $51.27,

D.R. Horton

(DHI) - Get Report

jumped 4.1% to $24.62, and

Toll Brothers

(TOL) - Get Report

rose 3.8% to $27.44.

Lennar

(LEN) - Get Report

-- which early Monday

reported a 33% jump in earnings for the second quarter but also reduced its full-year earnings guidance -- rose 3.5% to $46.06.