* Ifo highest in 10 months, biggest rise since July 2010
* Sees Q1 GDP growth of 0.2 pct after Q4 contraction
* GDP fall of 0.6 pct is biggest since start of 2009
By Michelle Martin and Annika Breidthardt
BERLIN, Feb 22 (Reuters) - German business morale surged at its fastest pace in over two years in February, pushing higher for a fourth consecutive month and pointing to a solid recovery in Europe's largest economy after a dismal end to 2012.
The Munich-based Ifo think tank said on Friday its business climate index, based on a monthly survey of some 7,000 firms, rose to 107.4 in February, up from a revised 104.3 in January.
That was the biggest one-month rise since July 2010 and beat even the highest estimate in a Reuters poll of economists. The euro and European shares rose after the data.
Germany's economy shrank by 0.6 percent in the fourth quarter, succumbing to a sharp fall in demand from its euro zone trading partners, but economists expect the gloom to be short-lived and do not see Germany slipping into a recession, defined as two quarters of contraction.
"German economic confidence surveys seem to be showing more signs of economic spring, but the economy is still struggling with a massive millstone round its neck, the rest of the beleaguered euro zone economy," said David Brown of New View Economics.
Reflecting the poor outlook for Germany's neighbours, the EU Commission on Friday said the euro zone economy would not grow until 2014 and downgraded its forecast for German growth this year to 0.5 percent from 0.8 percent previously.
Ifo itself expects gross domestic product (GDP) growth of 0.2 percent quarter-on-quarter in the first three months of the year.
Ifo's sub-index on current conditions rose to 110.2 from 108.1 in January, while a gauge of expectations shot up to 104.6 from 100.6.
Still, while sentiment indicators now point to a solid first-quarter rebound in Germany, they have not yet been backed up by much hard data. The most recent export, industrial orders and output figures point to only a slight uptick.
EXPORTS SEEN RECOVERING
Ifo economist Klaus Wohlrabe said he expected exports, the traditional backbone of the economy, would regain momentum and noted that the investment backlog was beginning to clear.
Data released earlier on Friday showed that a plunge in exports drove the strong contraction in fourth quarter GDP, offsetting support from domestic demand and inventories.
The 0.6 percent GDP fall was the biggest since the economy shrank by 4.1 percent at the start of 2009, in the wake of the Lehman Brothers bankruptcy, and it was only the second contraction since the 2008/09 recession.
Foreign trade deducted 0.8 percentage points from GDP while domestic demand added 0.2 percentage points.
"The data from the fourth quarter is relatively bad. That was a one-off," said Ulrike Kastens at Sal. Oppenheim.
"For the current quarter we expect to see growth again. Exports will probably revive and domestic demand will develop stably."
Friday's breakdown of GDP data showed exports dropped by 2.0 percent in the fourth quarter while imports fell by 0.6 percent, boding ill for struggling euro zone states which had hoped to offload more of their goods on Germany, where rising wages, high employment and moderate inflation have boosted domestic demand.
Private consumption rose by 0.1 percent on the quarter and public consumption was up by 0.4 percent.
Investment in equipment has been falling for more than a year now and dropped by 2.0 percent in the fourth quarter as firms spent less on machines, tools and vehicles, the Statistics Office said.
Many German companies are cutting costs, with steelmaker ThyssenKrupp recently saying it wants to cut 500 million euros ($669.5 million) in costs over the next three years at its European steel operations.
Germany's economy nonetheless remains in good shape compared to struggling euro zone peers like Greece and Italy, where gross domestic product shrank by 6.0 percent and 0.9 percent respectively in the fourth quarter.
Surveys released this week have shown morale among German analysts and investors climbing to its highest level in nearly three years this month and private sector activity increasing for a third straight month.
Germany grew by a post-reunification record of 4.2 percent in 2010 and by some 3 percent in 2011 but growth slowed to 0.7 percent last year as exports suffered due to sagging demand in the euro zone and firms cutting back on investments.