UPDATE 2-Brazil July industrial output up less than forecast

* Industrial output rises 0.4 percent in July vs. June

* Output jumps 8.7 percent year-on-year

* Yields on rate futures drop on below-forecast data (Adds analyst comment)

SAO PAULO, Aug 31 (Reuters) - Industrial production in Brazil rose less than expected in July from June, underscoring the economy's slower pace of expansion compared to torrid, perhaps unsustainable, first-quarter growth.

Output rose 0.4 percent in July from the previous month, government data showed on Tuesday, only half the median forecast of 0.8 percent from 17 analysts in a Reuters survey. The forecasts ranged from 0.2 percent to 1.4 percent.

With central bank policy-makers meeting on Tuesday and Wednesday to consider changing the benchmark interest rate, yields on Brazilian interest rate futures contracts <0#DIJ:> slid on the data.

The yield on the contract due January 2012 DIJF2, the most widely traded of the early session, slipped as low as 11.35 percent from 11.41 percent, signaling lowered expectations for interest rate hikes in coming months.

"We believe this weak opening for Q3 supports our thesis of a slowing Brazilian economy leading to (central bank) rate cuts in 2011," wrote Nomura Securities' emerging markets research Americas chief Tony Volpon.

Industrial production declined in every month in the second quarter, including a revised 1.1 percent industrial production decline in June versus May.

The signs of a second-quarter economic slowdown from the 9 percent year-on-year expansion in the first quarter have prompted many analysts to revise down their year-end Selic expectations. Official quarterly GDP figures are due to be released on Friday.

Central bank policy-makers began a tightening cycle in April after Brazil's economy expanded at its fastest rate in more than a decade over the first quarter, taking the Selic rate to 10.75 percent from 8.75 percent in three separate meetings.

Most analysts in a Reuters poll see the bank keeping the Selic at its current 10.75 percent this week. [ID:nSPG003024]

Nomura's Volpon sees the Selic falling to 10 percent in 2011.

CAPITAL GOODS, MACHINERY DECLINE

Of the 27 industrial sectors surveyed, 17 advanced, including autos, pharmaceuticals and chemical products. Among sectors which declined were machinery and metal products.

In broader industrial categories, output of capital goods slipped 0.2 percent in July from June, the IBGE said. Production of consumer goods rose 0.4 percent month on month, and durable consumer goods added 0.9 percent.

July's industrial production jumped 8.7 percent BRIOY=ECI compared with July 2009, slowing from the previously reported 11.1 percent leap in June compared with a year earlier.

Production had been expected to surge 9.1 percent over July 2009, according to the Reuters survey, with expectations for the jump ranging from 8 percent to 11.1 percent.

For details on the IBGE's industrial output figures see: here (Reporting by Rodrigo Viga Gaier and Stuart Grudgings; Writing by Luciana Lopez, Editing by W Simon )