SYDNEY, Oct 7 - Activity in Australia's construction industry took a spill in September due to a severe deterioration in home and commercial building amid a deepening credit squeeze, a private survey showed on Tuesday.

The Australian Industry Group/Housing Industry Association performance of construction index (PCI) dropped 11.3 points to 31.8, the lowest reading since the survey began in September 2005. It was the seventh straight month of contraction, being far below the 50.0 level seperating expansion from contraction. "The on-going credit squeeze and deteriorating economic sentiment contributed to a marked fall in demand for building projects," said Tony Pensabene, AIG Associate Director Economics and Research.

"This is particularly evident in the sizeable reductions in work on apartment and commercial developments during September and the persistant weakness in house building activity."

The index for house building dropped to a lowly 27.9, from 34.5 in August, while the measure of commercial construction sank 22 points to 35.1, the survey of 120 companies showed.

There was some improvement in the once-strong engineering sector, with that index bouncing 8.2 points to 42.6, though that was still below the 50.0 threshold.

Disturbingly for the future, the index of new orders fell further to just 31.5 in September, after dropping to 37.9 in August.

"Of concern, new orders for the industry as a whole are now at their lowest level in three years, signalling that the current weakness in activity is likely to continue during the months ahead," said Pensabene.

The dismal survey reinforced the need for cuts in official interest rates, he added.

The Reserve Bank of Australia (RBA) holds its monthly policy meeting on Tuesday and is now widely expected to cut its cash rate by an aggressive 50 basis points to 6.5 percent, seeking to cushion the economy from global market turmoil.