* Surprise drop suggests pace of economic recovery is feeble
* Peugeot chief sounds positive note despite industry's woes
* Latest data comes as government prepares to unveil 2014 budget
By Brian Love
PARIS, Sept 10 (Reuters) - French industrial output unexpectedly fell in July as oil and coke refining and car production shrank, confounding forecasts for the euro zone's second-biggest economy to make a solid start to the third quarter.
The data suggests the economy is still fragile after pulling out of recession in the second quarter, adding to the challenge facing President Francois Hollande's government as it puts the final touches to a 2014 budget that must cut debt without killing nascent economic recovery.
Industrial output fell 0.6 percent in July from June, seasonally adjusted, the INSEE statistics office said on Tuesday. Oil and coke refining fell 6.7 percent on the month, while car production dropped 11.2 percent, pointing to a deepening slump in the sector after a 7.4 percent decline in June.
A Reuters poll had forecast a 0.6 percent increase in industrial output in July, after a 1.4 percent decline in June.
"Today's report shows a weaker-than-expected entry of industrial production into the third quarter," said Tullia Bucco, an economist at UniCredit bank.
The French central bank raised its growth forecast for this quarter slightly on Monday to 0.2 percent, quarter-on-quarter, following a recent improvement in economic data.
Bucco, however, said she expects quarterly growth will slow to 0.1 percent in the July-September quarter after a 0.5 percent rise in the second quarter.
Finance Minister Pierre Moscovici, whose 2014 budget bill is due to be unveiled on Sept. 25, said on Tuesday that he hoped signs of a broader recovery in Europe would help France meet or beat the government's growth forecast of 0.1 percent this year.
"The (growth) number of 0.1 pct seems to me to be a very cautious estimate to work with in 2013. For 2014, we want to build on the recovery in France to make it sustainable," Moscovici told a seminar at the finance ministry. "France has everything it needs for that with the euro zone doing better as it recovers, and with the pillars of domestic demand solid."
Struggling carmaker PSA Peugeot Citroen sounded a more upbeat note on the outlook for the car sector, saying renewed weakness in European sales during the traditionally slack summer vacation period of August, did not appear to have continued.
"For the moment our September orders are at a similar level to last year," Chief Executive Philippe Varin told reporters at the Frankfurt auto show. (Additional reporting by John Irish and Leigh Thomas in Paris, and Laurence Frost in Frankfurt; Editing by Susan Fenton)