* Industry orders -1.3 pct vs f'cast +1.2 pct
* Domestic demand for capital goods -4.1 pct
* Economist says points to ongoing weak investment
By Sarah Marsh
BERLIN, July 5 (Reuters) - A slide in demand for capital goods at home drove an unexpected 1.3 percent drop in German industry orders in May, underscoring fragility in Europe's largest economy and disappointing hopes it might support regional growth.
The second monthly drop in seasonally and price-adjusted order intake compared with a consensus forecast in a Reuters poll of 37 economists for a 1.2 percent rise. It was a steeper fall than even the lowest forecast for a 0.7 percent slide.
"The decline is a bitter disappointment," said Andreas Scheuerle, economist at Dekabank. "The fall in domestic orders for capital goods is worrying, as this points to a continued weakness in investment."
Scheuerle said German companies had held back on investments since the euro zone's debt crisis escalated in 2011.
"We need at long last positive news on the debt crisis to reduce the uncertainty - the events in Portugal were counterproductive in this regard," he said, referring to a political crisis in Portugal that flared up this week, threatening Lisbon's adjustment under a bailout.
Recent data has painted a mixed picture of the German economy, which held up well in the first few years of the euro zone's debt crisis but shrank at the end of last year, only narrowly avoiding a recession in the first quarter of 2013.
Sentiment surveys have improved and exports, imports and output have all risen. But a Purchasing Managers' Index (PMI) published earlier this week showed the manufacturing sector shrank in June, while Germany's VDMA engineering association on Thursday slashed its forecast for 2013 production.
Industry orders fell by a revised 2.2 percent in April, according to the data from the Economy Ministry. They were originally reported to have fallen 2.3 percent. The fall is already seen feeding through to output in May, which is forecast to have dropped by 0.5 percent.
Domestic orders fell 2 percent, with demand at home for capital goods slumping 4.1 percent, raising concerns that the domestic economy will not be able to compensate for sluggish demand from the euro zone, where Germany's traditionally export-oriented economy ships some 40 percent of its goods.
Industry orders from abroad dropped 0.7 percent in May, driven by a 3.9 percent fall in orders from the euro zone.
The Economy Ministry said a lack of big-ticket items contributed to the weak industry orders data.
The German economy is still outperforming peers within the euro zone. Data on Friday showed France's trade deficit with the rest of the world widened sharply in May, while Spain's industrial output fell for the 21st month in a row.