By Sarah Marsh and Maria Sheahan
BERLIN/HANOVER (Reuters) - German industrial output rose in February and industry leaders were cautiously optimistic about growth and investment in Europe's largest economy this year as long as there is no flare-up in the euro zone crisis.
Coming on the heels of figures showing a stronger-than-expected rise in industrial orders in February, Economy Ministry data on Monday showed output edging up 0.5 percent on the month. This was above the mid-range forecast in a Reuters poll of economists for a 0.3 percent rise.
But industrial output still fell 0.2 percent in the first two months of the year due to a downwardly revised drop in production of 0.6 percent in January. Output last month was originally reported unchanged.
Leaders of industry groups at a conference in the northern city of Hanover said the economy was already rebounding after shrinking in the fourth quarter of 2012 and would accelerate in the second half of this year.
"We see good chances that the economy will pick up steam in the course of the year," said Ulrich Grillo, the head of the BDI industry lobby group, predicting growth of up to 0.8 percent.
Germany's economy, long resilient to the euro zone crisis, slowed in 2012 and output shrank by 0.6 percent in the final quarter. But economists expect it to avoid recession and to have returned to weak growth in the first three months of 2013.
German growth is crucial for stimulating the economy of the broader single currency bloc, struggling with a debt crisis and mired in recession. The government is predicting an expansion of just 0.4 percent this year.
Monday's data showed a rise in German production of capital goods and energy in February outweighing a sharp drop in construction, which was partly due to harsh winter weather.
"Production is stabilising once again after the sharp decline at the end of last year," said Unicredit analyst Alexander Koch. "Given that retail sales is also rising and investments are stabilising, we expect a return to economic growth in the first quarter."
Unicredit's Koch said the increase in orders and production of capital goods such as machinery was especially positive news for Germany's economy, which he sees growing 0.3 percent in the first quarter, as it spelled out a rebound in investment.
Manufacturing output increased by 0.5 percent as a 2.4 percent rise in capital goods such as machinery outweighed decreases in consumer and intermediate goods, the data showed.
Figures last week had shown domestic orders for capital goods jumping 4.4 percent, which the Economy Ministry said set the stage for a revival in investments. Industry orders rose 2.3 percent overall in February.
The BDI said a pickup in investments, which had been in contraction for five quarters, was crucial for economic recovery this year, while the steel lobby said the biggest risk remained the euro zone crisis.
The problems with Cyprus had already weighed on German business sentiment, which dropped in March, and worries over Italy could dampen morale in the long-term, the head of the steel lobby, Hans Juergen Kerkhoff, said.
"Without a return of confidence there will be no rebound in capital goods and therefore also not in the outlook for the steel industry," he said, reiterating his association's estimate for steel output to rise miminimally to 43 million tonnes this year, still well below levels of five years ago.
With federal elections looming in September, the BDI's Grillo warned against some of the centre-left opposition's policy proposals such as raising inheritance tax or introducing a wealth tax, which he said would weigh on the industrial sector.
The VDMA and ZVEI trade bodies for the engineering sector and the electrical goods industry said they had seen a moderate pickup in business this year.
"New orders have picked up again, so there is an upward trend. But it is not so dynamic that we are becoming overly optimistic," said Ralph Wiechers, the VDMA's chief economist.
"Two percent (engineering output growth) are do-able this year, but we will need some more tailwind from the economy, from indicators and global markets."
Exceptionally harsh winter weather prevented Germany's industrial sector from rebounding strongly this quarter, economists said. Production in the construction sector dropped 2.7 percent, according to Monday's data.
"The harsh winter weather has not only affected the construction sector but the entire industry," ING analyst Carsten Brzeski said. "Interestingly, the German economy has been hit much harder by the winter weather than the rest of the euro zone. Some might consider this a meteorological-inflicted rebalancing."
Brzeski said this explained the divergence this year between weak economic data and optimistic sentiment surveys. Recent polls have shown consumer morale holding steady going into April, and investor sentiment edging up.
Monday's output data also showed energy production jumping in February, by 3.9 percent. Figures last week showed Germany exported more electricity last year than it imported, dispelling fears about possible power shortages due to its transition from nuclear to renewable energy.
The story is refiled to delete repetition in eighth paragraph)
(Additional reporting by Klaus Lauer in Berlin and Tom Kaeckenhoff in Hanover,; Editing by Gareth Jones and Catherine Evans)