* Nationwide Feb core CPI -0.3 pct yr/yr vs forecast -0.4 pct * Output falls 0.1 pct in Feb vs forecast +2.6 pct * Softer demand for smartphones hurt parts output * Analysts expect output fall to be blip, recovery eyed * BOJ likely to ease policy, overhaul framework next week By Leika Kihara and Kaori Kaneko TOKYO, March 29 Japan's factory output unexpectedly dipped in February on a drop in electronics production and consumer prices fell again, underscoring the challenge the central bank faces in engineering a sustained recovery and achieving its 2 percent inflation target. Exporters are hoping to see the benefits of a weaker yen, the product of the new government's push for massive fiscal and monetary stimulus, in coming months, but they are also reliant on global demand improving for that upswing to happen. Industrial output slid 0.1 percent last month, pulled down by a 5 percent drop in electronics output. Expectations had been for a rise of 2.6 percent, and the gap weighed on investor sentiment, with Nikkei share average flat at the midsession break on the last trading day of the fiscal year. Core consumer prices also fell 0.3 percent from a year earlier, strengthening the case for the Bank of Japan to ease monetary policy further at its policy meeting next week. The BOJ is likely to start open-ended asset purchases immediately rather than in 2014 and consider setting a new target to buy longer-dated bonds, sources say, in a show of its resolve to beat nearly two decades of deflation. New BOJ Governor Haruhiko Kuroda has set an ambitious target of achieving the central bank's 2 percent inflation target in two years, but many analysts see that as unrealistic. "It will take about six months for a weaker yen to be felt in exports, while overseas economies including China have not yet gained momentum in their recovery," said Takeshi Minami, chief economist at Norinchukin Research Institute in Tokyo. WAITING FOR WEAK YEN The drop in output followed a 0.3 percent rise in January and a 2.4 percent gain in December last year, data from the Ministry of Economy, Trade and Industry showed on Friday. Most of the decline was due to a 5.0 percent drop in output of electronic parts. Companies may have over-estimated demand for smartphones, forcing them to cut output when orders were weaker than expected, analysts said. Media reports earlier this year said Apple Inc had slashed orders for iPhone screens and other components from its Asian suppliers, hurting Japanese parts makers such as Sharp Corp. "Demand for smartphones is growing but the increase wasn't as fast as companies expected. Still, demand isn't declining sharply, so there's no big change to our forecast that Japanese exports and output will soon recover," said Yoshiki Shinke, chief economist at Dai-ichi Life Research Institute in Tokyo. Companies remained upbeat, suggesting the economy remained on track for a gradual recovery from last year's shallow recession. Manufacturers surveyed by the ministry expect output to rise 1.0 percent in March and 0.6 percent in April. The government maintained its assessment that output was bottoming out and showing some signs of a pick-up, as 10 out of 16 sectors surveyed saw increases in production including car makers, which benefitted from strong sales in the United States. Dai-ichi's Shinke said the benefits of the weakening yen, which hit a 3-1/2 year low against the dollar this month, should be seen in exports from the April-June quarter, or the following quarter at the latest. In another encouraging sign, the Markit/JMMA Japan Manufacturing Purchasing Managers survey showed overall manufacturing activity growing in March for the first time in 10 months. Separate data from the Internal Affairs ministry showed core consumer prices, which exclude fresh food but include energy costs, fell 0.3 percent in February from a year earlier, a fourth straight month of declines. That was a slightly smaller fall than a median market forecast of a 0.4 percent drop. March data for the Tokyo area, available a month earlier than nationwide data, showed the trend extending with core prices slipping 0.5 percent. However, declines in consumer prices are likely to slow in coming months as the weak yen pushes up the cost of energy imports and as fiscal spending narrows the output gap, economists say. Japan has been mired in mild deflation for almost two decades, and Prime Minister Shinzo Abe has made economic revival and escape from deflation top priorities.