* Twitter drops after brokerage downgrade
* Toll Brothers up on revenue beat
* New U.S. home sales touch 8-year high in April
* Indexes end up: Dow 1.22 pct, S&P 1.37 pct, Nasdaq 2.0 pct (Updates to close)
By Noel Randewich
May 24 (Reuters) - Wall Street surged over 1 percent on Tuesday and the Nasdaq had its strongest day in three months as investors made peace with the possibility that the U.S. Federal Reserve might soon raise interest rates.
Comments from policymakers in recent days have investors expecting a rate hike potentially in June, much sooner than previously thought given sluggish economic growth.
Wall Street has benefited from historically low borrowing costs since the 2008 financial crisis and higher rates could choke further gains. But strategists on Tuesday said they were reassured by expectations the Fed would tighten borrowing costs only gradually.
"The market is starting to contemplate the idea that Fed rate hikes this year are A: more likely, and B: not inherently bad in and of themselves," said Bill Merz, an investment strategist with U.S. Bank Wealth Management.
Shares rose in the banking sector, which stands to gain from higher interest rates. Bank of America, Citigroup and JPMorgan all rose over 1.4 percent.
Microsoft jumped 3.12 percent and provided the biggest boost to the Nasdaq and S&P 500, while 3M Co's 1.52-percent rise lifted the Dow.
It was the strongest session since March 1 for the Nasdaq Composite and since March 11 for the S&P 500. So far in 2016, the S&P 500 is up about 2 percent and the Nasdaq is down 3 percent.
Data on Tuesday showed new U.S. single-family home sales surged to a more than eight-year high in April and prices hit a record high, offering further evidence of a pick-up in economic growth.
The Dow Jones industrial average jumped 1.22 percent to end at 17,706.05 and the S&P 500 rallied 1.37 percent to 2,076.06.
The Nasdaq Composite surged 2 percent to 4,861.06.
Gains were broad-based, with all 10 S&P sectors rising and the tech sector up 2.12 percent.
Oil reversed early losses to turn positive, as investors awaited crude oil inventory data from the United States that was expected to show a shrinking supply overhang.
Homebuilder Toll Brothers jumped 8.71 percent after quarterly revenue beat expectations.
Twitter fell 2.64 percent after brokerage MoffettNathanson downgraded the company's stock to "sell" from "neutral".
About 6.9 billion shares changed hands on U.S. exchanges, below the 7.2 billion daily average for the past 20 trading days, according to Thomson Reuters data.
Advancing issues outnumbered decliners on the NYSE by 2,324 to 701. On the Nasdaq, 2,210 issues rose and 603 fell.
The S&P 500 index showed 29 new 52-week highs and one new low, while the Nasdaq recorded 87 new highs and 29 new lows. (Additional reporting by Tanya Agrawal; Editing by Nick Zieminski)