UPDATE 1-Japan factory output unexpectedly falls in June

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* June industrial output falls 1.5 pct vs f'cast +0.2 pct

* Core CPI posts 16th straight month of annual falls (Adds analyst quotes, details)

By Stanley White

TOKYO, July 30 (Reuters) - Japanese factory output marked its biggest fall in more than a year in June and manufacturers expect further declines in July, boding ill for the fragile economic recovery faced with a strong yen and moderating overseas demand.

Core consumer prices posted their 16th straight month of annual declines in June, suggesting that domestic demand still lacks strength and may slow Japan's exit from deflation.

While analysts had expected factory output to slow from recent sharp gains, the drop in June and slowing export growth suggests the economic recovery may lose momentum and add pressure on the Bank of Japan to ease monetary policy further.

"The recent slowdown in exports has started to affect production and there may be more downside risks if China's economy slows down. Output is likely to level off in coming months at best," said Takeshi Minami, chief economist at Norinchukin Research Institute.

"The latest series of data has increased the possibility of the Bank of Japan easing its policy further. The BOJ could lower the policy rate or increase its Japanese government bond buying."

Industrial output unexpectedly fell 1.5 percent in June, surprising markets that expected a 0.2 percent increase and marking the biggest decline since February 2009, data from the Ministry of Economy, Trade and Industry showed on Friday.

Manufacturers surveyed by the ministry expect output to fall 0.2 percent in July and increase 2.0 percent in August.

Separate data showed core consumer prices, which include oil products but exclude fresh food prices, fell 1.0 percent in June from a year earlier, narrowing the margin of decline from May but decreasing for the 16th straight month. The drop was less than a median market forecast for a 1.1 percent fall.

Analysts expect falls in consumer prices to continue to ease gradually but say a convincing reversal is still distant as wage growth remains slow and government stimulus that has driven recovery in consumer spending will expire later this year.

The yen showed muted reaction to the raft of data, moving in a narrow range around 86.75 JPY= per dollar.

The Democratic Party-led government has vowed to beat deflation in the fiscal year starting next April but its hands are tied by huge public debts.

Analysts say the government may therefore lean on the Bank of Japan to support the economy, with its outlook clouded by signs of a slowdown in exports and an appreciation in the yen that hurts companies' export competitiveness.

In a draft proposal on Friday, a ruling party panel called for Japan to set an inflation target of 2-3 percent to overcome deflation. [ID:nTKU106163] (Additional reporting by Tetsushi Kajimoto, Rie Ishiguro and Kaori Kaneko, writing by Leika Kihara, editing by Charlotte Cooper)