CORRECTED-UPDATE 1-Bank of Italy sees gloom deepening for economy
(Corrects paragraph 3 to show recession began in third quarter 2011, not first quarter)
* Central bank slashes 2013 GDP view to -1.0 pct from -0.2
* Expects only 0.7 pct economic growth in 2014
* Report highlights economic challenges facing next government
ROME, Jan 18 (Reuters) - The Bank of Italy slashed its forecast for the country's shrinking economy on Friday, as tight credit conditions and a gloomy international backdrop darken the domestic outlook ahead of national elections in February.
The central bank said it now expects gross domestic product to slump by 1.0 percent this year rather than the 0.2 percent contraction it forecast in July.
In a quarterly economic report that highlighted the economic challenges that will face Italy's next government, the bank said the recession that started in the third quarter of 2011 would extend well into 2013.
It forecast only a modest and uncertain revival in the second half of this year and growth of just 0.7 percent in 2014, adding that the economy probably contracted by 2.1 percent in 2012.
Prime Minister Mario Monti, appointed at the height of the financial crisis in 2011 to prevent Italy's huge public debt from sliding out of control, has been widely credited with restoring international credibility.
But he has overseen a severe economic recession exacerbated by the tough austerity measures he has imposed, leaving a huge challenge for the government that will succeed his technocrat administration following the Feb. 24-25 ballot.
Underlining the damage done to the euro zone's third largest economy since the start of the crisis, the Bank of Italy said that even after the forecast return to growth in 2014 gross domestic product would still be left almost 7 percentage points below the level of 2007.
The report estimated Italy's public deficit fell to around 3 percent of gross domestic product in 2012, from 3.9 percent in 2011.
It gave no precise deficit estimate for the current year, when the government has forecast a balanced budget in structural, or growth-adjusted terms, but said that budget measures undertaken in 2011 would "allow an improvement in the balance of public finance in the 2013-2014 period."
It said the debt-to-GDP ratio, which the government estimates will reach 126.1 percent in 2013, would start to come down in 2014, thanks to an improvement in the primary surplus - which excludes debt servicing costs - and a return to economic growth.
The bank's new forecasts are significantly more pessimistic than government forecasts from October, which see the economy contracting by 0.2 percent in 2013 before returning to growth of 1.1 percent in 2014.
The report said that whichever government came to power after the elections would have to continue rebalancing public finances and pursuing reforms to restore Italy's economic competitiveness.
(Reporting by James Mackenzie; Editing by John Stonestreet)