ANALYSIS-German industry will pick up, not enough to buoy eurozone
* Firms blame weak euro zone demand for slower growth
* Industry output, orders down 1.8 pct in five months to end-May
* Manufacturing sector seen picking up in H2 and 2014
BERLIN, July 26 (Reuters) - German manufacturing, the backbone of Europe's largest economy, will slowly regain momentum after a weak start to the year but its recovery is unlikely to be strong enough to help the rest of the currency bloc.
Manufacturing, which makes up around one fifth of Germany's economy, has shrunk five out of seven months this year as the euro zone's troubles erode demand close to home and China, which many firms looked to as a strong alternative market, weakens.
Factories have cut jobs, slashed their prices at some of the fastest rates in 3-1/2 years and resorted to working through backlogs of orders, purchasing managers' surveys show.
Despite such measures, industrial production and orders both tumbled by 1.8 percent on the year in the five months to end-May. Euro zone orders fell 2.9 percent and domestic orders in the export-oriented economy dropped by 3.6 percent.
Only contracts from outside the euro zone rose.
"It's a story of modesty rather than a story of an economic miracle or Superman's cape now but it's not a story of the manufacturing sector crashing either; it's somewhere in between," said Carsten Brzeski, senior economist at ING.
"Germany won't be strong enough to pull the entire euro zone out of recession. It will remain the strongest player and the engine for the next couple of years but it no longer has a turbo which could help others out significantly."
ACTech, a firm which makes casting prototypes and small batches, said the start to the year had been tough as its clients, mostly carmakers and their suppliers, were unnerved by developments in the bloc.
Surveys have shown the rocky road to bailing out Cyprus in March particularly worried companies and investors.
But business has begun to pick up.
Orders at the 389-strong firm in eastern Germany fell short of targets by 10 percent in the first quarter and the company, with annual sales of 36 million euros, also suffered a major setback in April when new bookings were 40 percent below projections.
"We had a bad April in terms of orders and we think that's due to political uncertainty after the crisis in Cyprus," managing director Florian Wendt told Reuters.
"In May and June the situation improved but it hasn't completely recovered yet," he said, adding clients who had put off orders in April were now shedding some of their cautioun so he was "not at all pessimistic" about the future.
German's industrial giants are also suffering, with profit at chemicals maker BASF falling on weaker European and Chinese demand and engineering conglomerate Siemens abandoning its 2014 profit target.
Daimler, however, looks to be recovering after a poor start to the year. That is in line with economists' and other firms' beliefs that a moderate pick-up is in sight as long as the euro zone's troubles remain at bay.
ALL ABOUT EURO ZONE
The share of exports Germany sends to the currency area has fallen during the crisis but remains at almost 40 percent. While the proportion of shipments it sends to China has risen, it is still negligible compared to the euro zone at 6 percent and will not be enough to haul the sector out of difficulty.
"We're worried about the euro zone crisis as if it worsens, it could lead to a downturn among our clients and strong sales to China wouldn't help much in that situation. Europe is so big it would hit our customers quite hard," said ACTech's Wendt.
DELO, an industrial adhesives manufacturer with annual sales of 52 million euros and 350 employees, is also facing slowing demand. Co-managing director Sabine Herold said business was "not as euphoric as in previous years", with sales growth slowing to 16 percent this year from almost 40 percent in 2010.
However, if the euro zone crisis is vanquished, Germany could post industry output growth of 0.9 percent on the year, according to a Reuters poll of economists. That would be a far cry from stellar growth of 2010 and 2011, but better than last year's 1 percent drop.
The poll also predicted output would rise by 3 percent next year as Germany's export markets pick up.
Engineering, which outpaced the wider economy by more than four times in 2011 and grew almost twice as strongly as gross domestic product in 2012, is expected to suffer a 1 percent drop in output this year, according to the VDMA association.
But the VDMA is upbeat about 2014 and with engineering exports to China and the United States increasing in April for the first time this year and expected to continue growing for the rest of the year, there are already signs of improvement.
While data on the wider German economy has been mixed, a key survey showed business morale rose for a third straight month in July, with manufacturers more upbeat about their business situation.
Helaba economist Stefan Muetze said falling producer prices had led to firms delaying raw material purchases hoping to buy them cheaper later. They would need to restock in the second half and likely give the chemical and steel industries a boost.
(Additional reporting by Anneli Palmen in Duesseldorf, editing by Mike Peacock)