UPDATE 2-German data shows mixed start to quarter, tempers optimism
* Trade surplus narrows as imports gather pace
* Industry output unexpectedly falls in October
* Other euro zone states anxious to sell more to Germany
* Sentiment indicators point to recovery
BERLIN, Dec 9(Reuters) - Germany's trade surplus narrowed in October on a jump in demand for imports from firms and households, while industrial output unexpectedly fell, signalling a mixed start to the fourth quarter for Europe's biggest economy.
Factory production dropped for the second month running, though the economy ministry said forward-looking sentiment data and robust construction orders indicated production would rise in the next months.
The 1.7 percent month-on-month decline in output followed disappointing data on Friday that showed industrial orders posting their biggest fall in nearly a year in October.
Trade data gave more cause for cheer, both for Germany and its euro zone peers. Imports rose 2.9 percent on the month and exports rose 0.2 percent, to give a surplus of 16.8 billion euros - smaller than the consensus forecast for 18.0 billion.
"With a narrowing trade surplus and dropping industrial production the German economy did not have the overwhelming start to the fourth quarter confidence indicators had suggested. Still, in our view, the economy should pick up speed again, ending the year on a positive note," said economist Carsten Brzeski at ING.
Germany has come under fire for relying too heavily on foreign trade and running high trade and current account surpluses at a time when the euro zone economy needs support.
Criticism came also from Washington that Berlin must do more to spur domestic demand, and that its reliance on exports was hurting the global economy.
On an unadjusted basis, German exporters sold goods worth 99.1 billion euros in October, a record high for a single month, but imports from the euro zone rose 3.4 percent on the year.
"Investment is recovering and households are spending more. This means imports are outpacing exports... and we are now no longer seeing growth based so exclusively on exports," said Stefan Schilbe, an economist from HSBC Trinkaus.
Trade activity is expected to subtract from rather than contribute to economic growth in 2013, while currently still weak domestic demand will drive Germany's modest expansion.
October's fall in industry output compared with a Reuters consensus forecast for a 0.8 percent rise. A two-month average for September and October showed output easing 0.5 percent, data published on Monday showed.
"Industrial orders suggest upwards momentum however, and construction orders are good," the ministry said. It added that strong sentiment data suggested output would improve in the next months.
The Bundesbank last Friday raised its forecasts for growth in Germany to 0.5 percent from 0.3 percent this year, and to 1.7 percent from 1.5 percent next year.
Adding to the upbeat mood, an investor sentiment index for Germany published by Sentix on Monday climbed to its highest level since December 2010, propped up by an rise in economic expectations to a record high.
The German economy put in a strong performance during the early years of the euro zone crisis but weakened last year and had a subdued start to 2013. It bounced back in the second quarter and grew modestly in the third thanks to domestic demand as foreign trade dragged.
The central bank expects the economy to be "fairly strong" in the fourth quarter and first three months of 2014 as long as bad weather does not intervene. It said exports should rebound significantly at the end of this year.
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