* Ifo cuts forecast for 2013 German growth to 0.7 pct
* Says domestic demand, not exports, to boost economy
* Says economy to grow in Q1 2013 after contraction in Q4 2012 (Adds detail, quotes, background)
By Sarah Marsh
BERLIN, Dec 13 (Reuters) - German economic think tank Ifo on Thursday nearly halved its forecast for 2013 growth in Europe's largest economy to 0.7 percent but said domestic demand would help it pick up next year after a brief contraction this quarter.
Ifo said it was cutting its forecast from its June estimate of 1.3 percent growth as the euro zone's debt crisis had hit the economy later than expected, delaying the recovery.
The institute, which publishes the monthly survey of business sentiment in Europe's paymaster, said the economy would likely shrink 0.3 percent in the last quarter of 2012, only to grow 0.2 percent in the first of 2013.
"The German economy looks set to contract in the fourth quarter of 2012, before staging a recovery that is expected to be modest initially in 2013," Ifo said in a statement.
"If the euro crisis does not escalate and remains in line with the baseline scenario, domestic upward forces and rising demand for German export goods from outside the EU should boost the economy."
The think tank, which publishes its estimates twice a year, thus became the latest institution to cut its forecast. The Bundesbank last week slashed its own to a meagre 2013 expansion of 0.4 percent from a previous estimate of 1.6 percent.
Germany has been an engine of growth throughout the three-year euro crisis, but weakness elsewhere in the European Union, where it sells roughly 60 percent of its exported goods, is starting to bite.
The economy slowed in the third quarter and looks set to shrink this quarter, though it should still avoid recession.
Some recent signs have nonetheless been encouraging. Business sentiment surprised with a rise in November, breaking a six-month run of declines.
Ifo said trade would not contribute to growth next year in the traditionally export-driven economy, as domestic demand would boost imports and exports within Europe were weak.
Data earlier this week showed Germany's trade surplus narrowing to its lowest level in over half a year in the face of strongly rising imports and weakening demand from its recession-hit European partners.
Growth would derive instead from private consumption and investment in equipment and machinery, which had fallen sharply this year, Ifo said. Germany's engineering trade body earlier on Thursday reiterated its forecast for a moderate increase in 2013 output.
The VDMA engineering sector, which includes household names such as Siemens, returned to pre-crisis levels this year, and sees the growth rate remaining at 2 percent next year.
Ifo said unemployment would increase over the winter months but would fall again over the course of 2013, with the jobless rate rising by 0.1 percentage points to 6.9 percent next year.
Inflation meanwhile would ease to 1.6 percent from 2.0 percent in 2012, Ifo said.
The think tank said it saw the euro zone economy shrinking by 0.5 percent this year and 0.2 percent next year, although it would start to post growth over the course of next year on stronger exports and stabilizing private investment. (Additional reporting by Madeline Chambers, editing by Gareth Jones)