* Jobless claims hit record high in July
* Economists cut forecasts for 2011 GDP growth
* Credit supply continues to shrink
* Major mortgage provider warns on arrears (Recasts, adds details)
By Carmel Crimmins and Conor Humphries
DUBLIN, Aug 31 (Reuters) - Ireland's prospects for fully emerging from one of the industrialised world's worst recessions darkened on Wednesday after data on unemployment, credit flows and arrears pointed to an even gloomier outlook for domestic demand.
Ireland is relying on its export sector to break a three-year cycle of shrinking economic output this year but needs consumers to start spending again if it is to make inroads into its huge debt pile and emerge from an EU-IMF bailout by the end of 2013.
A Reuters poll showed local economists cutting their forecasts for gross domestic product (GDP) growth to 0.5 percent this year from 0.7 percent previously, the first downgrade in five monthly surveys.
They also trimmed their expectations for 2012 GDP growth to 1.9 percent from 2 percent and to 2.7 percent for 2013 from 2.85 percent previously.
"I think GDP growth could be somewhere between zero and 0.5 percent this year and possibly negative if things really deteriorate dramatically in the second part of the year," said Alan McQuaid, chief economist at Bloxham Stockbrokers.
What started out as a banking crisis in Ireland in 2008 morphed into a full-blown economic nightmare. Data on Wednesday showing the number of people claiming jobless benefit rose to a seasonally adjusted 449,600 in August, the highest level since records began in 1967.
Credit data on Wednesday also showed that deposit outflows continued in July and lenders have sharply cut the supply of credit to consumers, suggesting no uplift in domestic demand.
As the outlook for the global economy worsens, the prospect of turning around the unemployment situation appears dim.
"It's getting worse and I don't know how they (the government) are going to get people into work," said Brian, a 60-year-old painter whose trade, and that of his two sons, has mostly dried up. "It's gloom, gloom, gloom."
"I think it'll get better but it's going to take years and what's going to happen in those years?"
Rising unemployment is fuelling large increases in mortgage arrears, creating a headache for the government which has pledged to help struggling homeowners.
Over one in ten Irish mortgages are either in arrears or restructured due to financial distress, data on Tuesday showed.
Finance Minister Michael Noonan is expected to come up with proposals to deal with mortgage arrears after he receives a report from a group of experts in three weeks time.
Noonan has ruled out a blanket debt forgiveness scheme and said on Wednesday that banks must only write-off mortgage debt of people who can't pay their home loans.
David Guinane, the head of permanent tsb , one of the country's largest mortgage providers, said it was important people who don't want to pay their mortgage were not included.
"People who fall into the category of 'can't pay' will have to be defined as that and there can't be any margin for error," said Guinane at the group's interim results news conference.
"The challenges are huge. There is the moral hazard issue."
Rising arrears helped trigger a tenfold increase in first-half pretax losses at permanent tsb's parent group, Irish Life & Permanent , and the company said mortgage arrears in Ireland would keep rising until at least the middle of next year.
Writing off mortgage debt is a controversial topic in Ireland with many homeowners reluctant to let people who speculated during an ill-fated property boom off the hook.
"I've no problem with young people with genuine difficulties, but we can't just have a write-off that would go to those who speculated, those who jumped on the pig's back," said Alan, a local government official who declined to give his last name.
Ireland's government, back from its summer break this week, will unveil the latest in a long line of austerity budgets in December, further crimping consumer activity.
"The uncertainty has the effect that people do not spend the money even if it is still there," said Christoph Mueller, the chief executive of airline Aer Lingus .
"I am a little bit scared that if the austerity measures are kicking in fully, this might have an effect on discretionary spending." (Writing by Carmel Crimmins; Additional reporting by Padraic Halpin; Editing by Anna Willard)