UPDATE 2-India's industrial output recovers in Jan, rate cut still expected
* Industrial output +2.4 pct in Jan vs -0.5 pct in Dec
* Capital goods production falls; consumer goods recovers
* Retail inflation inches up to 10.91 pct in Feb
* Analysts expect RBI to cut interest rates on March 19
(Adds details, analysts quotes)
NEW DELHI, March 12 (Reuters) - India's industrial output expanded for the first time in three months in January, an early sign that Asia's third-largest economy may have turned a corner, but a sluggish recovery will likely keep the central bank on track to ease monetary policy further next week.
Production at factories, mines and utilities grew 2.4 percent in January from a year earlier, government data showed on Tuesday. The outcome was almost double the 1.2 percent forecast by analysts, and marked an encouraging bounce from an annual contraction of 0.5 percent in December.
However, the data highlighted pockets of weakness and underscored the challenges facing the economy as it struggles to motor on from a sharp slowdown. While production of consumer goods recovered, posting an annual growth of 2.8 percent in January, capital goods output -- a key investment indicator -- fell an annual 1.8 percent.
The sector has grown just once in the last 10 months.
Rupa Rege Nitsure, chief economist at Bank of Baroda, said the January data showed improved manufacturing activity, especially in electrical machinery production, chemical products and consumer non-durables.
"However, it's too early to comment on the sustainability of this trend. I still expect the RBI to cut policy rates by 25 basis points on Tuesday."
Worried about a deepening economic slump and encouraged by a slowdown in the headline inflation, the Reserve Bank of India (RBI) cut interest rates in January for the first time in nine months.
But it warned that room for further monetary easing was limited unless inflation and a high current account deficit improved by more than expected.
Expectations for any aggressive monetary easing were tempered by separate data on Tuesday that showed a pick-up in consumer inflation. Even so, investors are betting a sluggish economy will force the RBI to cut rates by another 25 basis points at its upcoming policy review on March 19.
India's economy has been hamstrung by weak capital investment and flagging consumer demand. A series of government policy U-turns and a slowdown in the rate of implementing key industrial and infrastructure projects have added to investor gloom.
The economy grew just 4.5 percent in the three months ending in December, the worst pace since the first quarter of 2009.
The government's preliminary estimates peg the full-year growth at 5 percent in the year ending in March, a sharp fall from the near double-digit growth rates of the mid-2000s, and the slowest growth in a decade.
"The data corroborates broad expectations that the consumption demand is showing signs of bottoming out, though the third consecutive monthly decline in capital goods production does not bode well for investment sentiment," said Radhika Rao, economist at DBS.
Consumer price inflation inched up to 10.91 percent in February from 10.79 percent a month ago, data showed.
But India's headline inflation, measured by the wholesale price index, has remained above 7 percent for the last three years before slowing down to 6.6 percent in January, edging closer to the RBI's perceived comfort level of around 5 percent. February WPI data, which the RBI weighs more heavily in setting policy, is due on Thursday.
Wholesale prices likely rose 6.54 percent during the month - the slowest annual rise since November 2009, according to a Reuters poll of 30 economists. The reading was 6.62 percent in January.
Following the data release, India's benchmark 10-year bond yield rose as much as 2 basis points to 7.87 percent. The partially convertible rupee trimmed gains to 54.31/32 per dollar, compared with 54.21/22 beforehand.
India's slowing growth is a major worry for the Congress-led coalition government as it gears up for a general election due by May 2014.
To kickstart investment, Prime Minister Manmohan Singh has set up a panel to speed up regulatory clearances for infrastructure projects and announced an investment allowance for new investments.
He has also opened retail and aviation sectors to more overseas investment, cut fuel subsidies and delayed tax changes that threatened to deter capital inflows.
Singh hopes these measures will script a turnaround and lift the growth rate to 6.1-6.7 percent in the new financial year that begins on April 1.
However, evidence of an economic revival is very thin so far. Merchandise exports have snapped a falling trend and grew for the second straight month in February. Manufacturing activity has also picked up.
Services growth, meanwhile, eased off sharply in February, while car sales slumped 25.7 percent in February, the biggest fall in more than 12 years and the fourth consecutive monthly slide.
Weak consumer demand forced Maruti Suzuki India Ltd , the country's biggest carmaker, to suspend production of petrol cars at one of its plants on Saturday. Sales at the company, controlled by Japan's Suzuki Motor Corp., fell 8 percent in February from a year earlier.
(Additional reporting by Manoj Kumar, Neha Dasgupta and Mumbai markets and treasury team; Editing by Sanjeev Miglani and Shri Navaratnam)