* New recession forecast -4.2 pct, pvs -4.8 pct
* Consumption holding up, says EU source
* Future recovery may be more subdued, say lenders
* EU source cannot exclude early markets return (Adds troika statement, para 5, detail para 6)
By Michele Kambas
NICOSIA, May 17 International lenders anticipate a shallower recession in Cyprus this year as private consumption continued to drive the economy, authorities said on Saturday, holding out the possibility of an earlier than envisaged return to international markets.
Lenders concluded their fourth mission to the island and said an economic adjustment programme was on track, Finance Minister Haris Georgiades told reporters.
"It was noted that progress was achieved in all sectors of the economy," Georgiades said.
Lenders, known as the troika, had lowered their expectations on the depth of recession to 4.2 percent, from a February projection of 4.8 percent, Georgiades and European Union officials said.
But future recovery was likely to be more subdued, given the high levels of unemployment, a liquidity crunch from high non- performing loans in the banking sector and indebtedness which could dampen consumption, the troika said in a joint statement.
Cyprus's economy contracted by 5.4 percent in 2013, more than 2 percentage points better than initial expectations. A return to growth of about 0.4 percent was anticipated in 2015, the IMF and the EU said.
"Consumption is holding up better than we expected," a senior European Commission source said, adding it was also due to the carry-over effect from 2013.
The source said the possibility of Cyprus returning to international markets earlier than its end-2015 game plan could not be discounted, given its performance so far.
Cyprus teetered on the verge of financial collapse in March 2013 after its banking system imploded from risky lending, exacerbating a cash squeeze on a state which has been shut out of financial markets for three years.
The island, one of the euro zone's smallest, required a 10- billion-euro ($13.7 billion) bailout and is following a three-year economic adjustment programme.
The positive review means that Cyprus will receive a new tranche of aid of about 686 million euros, mostly provided by the European Union, by the end of June. The amount will be used to finance the deficit and refinance maturing debt.
The new memorandum of understanding, a game plan of economic adjustment modified with every troika assessment, will call for reforms to Cyprus's public healthcare system.
"We think it is urgent," the commission source said.
Under the present timeframe, Cyprus anticipates a full return to financial markets by the end of 2015, even though Nicosia tested the waters for Cypriot debt with a private placement of bonds in April.
Georgiades avoided giving a direct answer when asked if the end-2015 timeframe could be moved earlier, saying it would be discussed with parliament.
Lenders say Cyprus is fully-funded and do not anticipate the island requiring more financial assistance than that in the bailout, the Commission source said.
"I wouldn't rule out that there will be a possibility of Cyprus returning to markets earlier. From a financing envelope perspective, its not strictly needed because it is fully funded," the source said.
Cyprus has consistently outperformed lenders' expectations after the bailout yanked the island from the brink of bankruptcy. It involved closing a major loss-making bank and imposing losses on large depositors in a second to recapitalise it.
The troika has also asked that banks directly affected by the bailout assess any connected lending practices by past or present board members or managers which may have caused "disproportionate losses".
The Bank of Cyprus had converted deposits to equity while the CoOperative Bank took 1.5 billion in taxpayers' money to recapitalise.
"We feel strongly that every reasonable attempt must be made to recoup that money," the Commission source said.
($1 = 0.7297 Euros) (Reporting By Michele Kambas; Editing by Rosalind Russell and Sophie Hares)