UPDATE 1-Strong Czech economic recovery remains distant prospect
* Output drop slows, but orders still poor
* Skoda Auto hit by western Europe, switch to new model
* Government sticking with tough austerity (Adds quotes from companies, background)
By Jan Lopatka
PRAGUE, March 15 (Reuters) - The Czech economy is barely crawling out of its longest recession since the 1990s, with manufacturing firms - seen as the Central European country's biggest strength - struggling to make headway as their customers in Western Europe flounder.
Industrial output continued to contract in January, albeit at a slower rate, and there was scant sign that companies could soon experience a pick up in new orders, according to data released on Friday.
Wary that the 10 million-strong country could succumb to the debt problems experienced by other European states in recent years, the government imposed tough austerity measures which have squashed spending by Czech households.
Although interest rates have been cut to almost nothing, the population have been reluctant to spend, and now Czech exporters - such as Volkswagen-owned carmaker Skoda Auto - are feeling the collapse of many of their target markets in the euro zone.
Friday's data showed manufacturing output fell by 4.1 percent in January, mainly due to shrinking car and car parts production, a blow for an economy with a higher proportion of industry per overall economic output than Germany.
The government believes the country is too dependent on the big European export markets, and has launched a campaign to win more orders from countries such as the BRIC nations.
These efforts have yet to bear much fruit. Czech companies are also vying for more orders from Russia, which had been a major market for the country in Soviet times.
The central bank, which has cut interest rates to just 0.05 percent, is also considering radical options to help the recovery. It has said it may intervene in the foreign exchange market later this year to weaken the crown currency if it feels the need to ease policy further.
This freedom to act plays well with the government and most Czechs, who believe the decision to stay outside the euro zone has helped the country remain competitive, and not put them on the hook for paying for bailouts of profligate southern euro zone members.
Analysts have been expecting the decline in gross domestic product to bottom out early this year, after a year and a half of recession.
There are no hopes for any big pick-up though, as higher unemployment and tax hikes continue to sap the retail sector and the government keeps spending tight.
The fiscal austerity has alienated voters, and the centre-right government is on track to lose an election planned for mid-2014, ushering in a Social Democrat-led administration that has promised to raise minimum wages and protect jobs at the expense of big firms and the rich.
Exports are also likely to remain subdued with forecasters only seeing around 1 percent growth this year in top destination Germany.
Czech growth for the full year is seen around zero, after a 1.2 percent drop in 2012.
There have been some signs of improvement in the past months.
Accolade, which runs industrial parks, said it has registered a pick-up in demand.
"Interest from potential clients clearly shows that the area of new investment projects is reviving," said Milan Kratina, managing partner at Accolade.
Another strength of the Czech economy is power, with the country being a major exporter of electricity. Majority state-owned power firm CEZ is the biggest listed company in Central Europe with market capitalisation of $16.5 billion.
CEZ has a presence in much of the Eastern part of Europe, although its investments abroad have run into difficulties in places such as Albania and Bulgaria.
Some forward-looking indicators have been more positive, with the February purchasing managers' index pointing to a stabilisation in activity.
But in official data, new orders disappointed, showing an overall decline of 7.6 percent.
"The data is yet to reflect the improving sentiment in Germany and in the end also the recent improvement of sentiment in Czech industry," said Radomir Jac, chief analyst at Generali PPF Asset Management.
"All in all, sentiment indicators have recently shown signs of improvement but hard data on output, orders and exports remained weak at the start of the year." (Reporting by Jan Lopatka; editing by Patrick Graham)