TOPWRAP 5-China factory output surges, U.S. auto sales jump

* 'Clunkers' bolster July U.S. auto sales

* First rise for UK manufacturing activity since March '08

* Major British banks see profits affected by bad debt

* German retail sales down, Metro warns of more declines

* China's factory output surges, euro zone nears recovery (Adds U.S. auto sales data)

By Peter Millership and Patrick Graham

LONDON, Aug 3 (Reuters) - China's factory output surged for a fourth straight month and the U.S. economy showed signs of improvement, including a jump in auto sales to their highest level of 2009 in July, according to reports on Monday,

Two of Britain's biggest banks, meanwhile, emerged from a year of financial turmoil in profit, but damaged by bad debts.

British manufacturing activity grew for the first time since March 2008, adding to evidence that the world's fifth biggest economy was over the worst of the recession, while the deterioration of the euro zone's factory sector looked closer to ending in July, surveys suggested. [ID:nL3668821]

That included modest output growth in three of the bloc's biggest economies, Germany, France and Spain. [ID:nL3631612]

"In the industrial sector, there's a very promising rebound and the economy will probably evolve much better than previous estimates," said Simon Junker at Commerzbank. "We expect positive growth in the second half of the year."

U.S. auto sales rose to their highest level of 2009 in July as Americans took advantage of a $1 billion "Cash for Clunkers" government handout that offers people taxpayer-funded rebates of up to $4,500 to swap out of older, less fuel-efficient cars.

General Motors [GM.UL], Ford (F.N) and Chrysler made nearly half the cars sold in the program. [ID:nN03389516].

U.S. July auto sales ran at a seasonally adjusted annual rate of about 11.2 million vehicles, the highest rate since last September, according to Reuters data. Ford posted a 2.0 percent sales increase, its first gain since late 2007. GM and Chrysler sales fell.

The U.S. manufacturing sector continued to shrink in July but at a slower pace than the previous month, according to an industry report.[ID:nN03439889]

The Institute for Supply Management's index of national factory activity rose to 48.9 in July from 44.8 in June. A reading below 50 indicates contraction in manufacturing.

U.S. construction spending rose 0.3 percent in June, topping forecasts, with the rate for public buildings reaching a record high, the Commerce Department said. It was the fifth month in a row that public construction, which makes up a third of U.S. construction spending, made gains. [ID:nN03512640]

An improving economic backdrop and upbeat quarterly company earnings have driven the world's stock markets .MSCI up around 55 percent since they bottomed out in March.

Stock markets rose on Monday, the 13th gain in the last 16 sessions, while the U.S. dollar hit its lowest level in 2009.

The economic data may point to a sustained recovery in major economies or just some stabilization, but the manufacturing surveys show that firms have finished running down stocks.

In China, an engine of growth for the world economy in the last decade, data showed factory output hit a one-year high, but it was spurred by domestic orders rather than still anaemic exports to the West. [ID:nPEK360544]

Other data published on Monday showed government measures to boost demand for new cars supported European car sales in July, with French sales rising 3.1 percent.

German retail sales, though, fell unexpectedly by 1.6 percent year-on-year in June, denting hopes that consumer spending would help bring Europe's biggest economy out of the worst recession since World War Two. [ID:nL3609599]

"In Western Europe we see possible signs of stabilization. However, talking today about green shoots would not be prudent," said Eckhard Cordes, chief executive of German retailer Metro -- the world's fourth largest -- after it posted falling second-quarter sales and profits.

"Clear signs for a fast economic upswing after the severe downfall are so far not discernible ... We expect that retail sales will further decline in the coming months."

RISKY GAINS

The stock market rally has been underpinned by the results of several of the world's biggest banks -- the European banking stocks index .SX7P is up 144 percent since March.

But those gains have come mainly from earnings from the risky investment banking business that started the credit crunch, rather than ordinary retail banking to companies and consumers.

Barclays Plc (BARC.L) missed expectations with an 8.0 percent rise in half-year profit. Bad debts almost doubled, offsetting earnings from an investment bank arm that swallowed much of investment bank Lehman Brothers after it collapsed last year.

Impairments and credit provisions on loans that have soured jumped 86 percent to 4.56 billion pounds for the half year.

HSBC Holdings (HSBA.L), Europe's biggest bank, said its first-half profits halved from last year to $5 billion because of rising bad debts in the United States, Europe and Asia.

HSBC reported a pre-tax profit for the six months to the end of June of $5.02 billion, down from $10.2 billion a year earlier but just ahead of an average forecast of $4.9 billion from 11 analysts polled by Reuters.

"It may be that we have passed, or are about to pass, the bottom of the cycle in the financial markets," Chairman Stephen Green said. "Nonetheless, the timing, shape and scale of any recovery in the wider economy remains highly uncertain."

HSBC shares rose to 642.4 pence at 1053 GMT, up 6.15 percent, while Barclays rallied to 326.5 pence, up 8 percent, as investors took encouragement from the possibility that the banks are through the worst.

The data outlook this week will be dominated by Friday's U.S. non-farm payrolls and unemployment report.

The New York Times reported on Sunday that up to 1.5 million Americans will exhaust their unemployment benefits in coming months, pushing more into home foreclosures and destitution. That may force Washington to extend benefits, officials said. (Reporting by Simon Rabinovitch in Beijing, Sarah Marsh in Berlin, Ross Finlay and Steve Slater in London and David Lawder in Washington. Additional reporting by Robert MacMillan in New York; editing by Andy Bruce and John Wallace)