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UPDATE 1-Weak August UK factory output dents recovery hopes

(Adds market reaction, economist comment)

By David Milliken and Sven Egenter

LONDON, Oct 9 (Reuters) - British factory output dropped in August and the country's trade deficit widened sharply, data showed on Tuesday, dampening prospects for a sustained recovery in the second half of 2012.

Manufacturing output dropped 1.1 percent in August after a downwardly revised bounce of 3.1 percent in July, the Office for National Statistics said. Economists had forecast a dip of 0.6 percent on the month.

Britain's goods trade deficit widened more than expected to 9.8 billion pounds, as exports fell and oil imports rose, and its total trade deficit - which includes buoyant services exports - rose to its second highest on record.

"Certainly it looks like the manufacturing sector is struggling and being affected by the very weak euro area economy and weak global backdrop," said Investec economist Victoria Clarke.

Sterling fell to a fresh one-month low against the dollar on Tuesday while UK share prices also declined.

Britain's economy has probably emerged from recession in the third quarter, but a vigorous return to health still looks elusive, keeping the pressure on the government and the central bank to boost growth.

The International Monetary Fund (IMF) slashed its forecasts for Britain's economy, predicting a contraction of 0.4 percent for this year and meagre growth for 2013.

CUTS

The country has not recovered the output lost during the 2008-2009 slump, and fell back into recession late last year.

Most economists think Britain achieved some growth in the third quarter as production bounced back from the effect of an extra public holiday in June, and ticket sales for the London Olympics and Paralympics added to gross domestic product.

Industrial output, which includes energy production and mining, fell 0.5 percent on the month in August, in line with expectations, after a 2.8 percent rise in July.

In more positive sign for the wider economy, retailers posted a solid rise in sales last month as Britons splashed out on sturdy shoes and warm clothes, and another survey showed that house prices fell at a slower rate.

But recent business surveys have shown a renewed weakening in sentiment, increasing concerns of an economic relapse as government spending cuts continue to hurt growth, and the euro zone debt crisis is hitting exports and business morale.

A sharp worsening in Britain's net exports had been one of the main drags on the economy in the second quarter, when output shrank by 0.4 percent.

With the government's hands tied by its pledge to erase the country's huge budget deficit over the coming five years, the onus is on the Bank of England to stimulate the economy.

Finance minister George Osborne vowed on Monday not to waver from his austerity plans, although the IMF said on Tuesday that he may need to defer some spending cuts planned for next year if the economy is much weaker than forecast. The IMF also said the BoE may need to loosen policy further.

Most economists expect the central bank to extend its quantitative easing purchases of government bonds once the current 50 billion pound round is completed in November.

(Additional reporting by Olesya Dmitracova and Li-mei Hoang. Editing by Jeremy Gaunt.)

((sven-markus.egenter@thomsonreuters.com)(+44)(20)(7542

7708)(Reuters Messaging: sven-markus.egenter.thomsonreuters.com@reuters.net))

Keywords: BRITAIN ECONOMY/