(Updates with economists' comments, market reaction)
* Euro zone manufacturing PMI at seven-month high
* Factory activity still deep in recession territory
* Orders to inventory ratio suggests production to pick up
By Nigel Davies
LONDON, June 1 (Reuters) - A severe euro zone factory recession eased in May and there were signs that companies were ready to pick up production even if job losses will keep mounting, a key survey showed on Monday.
The data pointed to an easing of a severe recession in the second quarter as order books picked up from depressed levels. But a recovery in growth may still be some time away.
The Markit Eurozone Manufacturing Purchasing Managers Index for May rose to a seven-month high of 40.7, up from 36.8 in April and just above the flash reading and economists' expectations for it to hit 40.5.
That was the biggest monthly jump in the survey's 12-year history, but it was still way off the 50.0 level that divides growth from contraction.
Earlier data showed a strong rise from weak levels across the euro zone's four largest economies. Germany saw its PMI hit a seven-month high and Italy an eight-month high, while France and Spain both jumped to their highest level in nine months. But all still held deep in recessionary territory.
The euro and financial markets showed little reaction to the data.
"The message we get is that the pace of contraction is shrinking and the worst is probably behind us, but it still does not suggest the recession is over yet and it's not likely to end any time soon," said Juergen Michels at Citi.
The output index rose to an eight-month high in May.
The orders to inventory ratio, a key gauge of pressure on companies to raise production, also rose steeply in the last month to 1.04 from 0.87 the previous month.
That was the highest since November 2007 and suggested that production may return to a level of stabilisation within the next three to four months if the positive trend continues, according to Markit.
The level of new orders and export orders taken by factories also declined at a much less dramatic pace in the last month, hinting that conditions bottomed in the first quarter and are now improving.
The euro zone economy shrank by a record 2.5 percent in the first quarter and is forecast to contract at a much less severe clip in the second.
However, while there were indications that the worst has passed, the employment index told a different story. While it rose in May it remained below the 40.0 mark for the sixth month running, suggesting unemployment in the euro zone will continue to rise for a long time to come even if the economy begins to pick up.
Euro zone unemployment rose to 8.9 percent in March and is forecast by many economists to smash through 10 percent by next year.
Tyre manufacturer Goodyear was set to cut 800 jobs at one of its factories in France, a French trade union said last week.
Separate price indexes for the PMIs showed inflationary pressures remain very subdued in the euro zone with manufacturers forced to slash costs to drive weak demand.
Official euro zone inflation fell to zero in May, and is forecast to fall further heading into the summer.
Still, most economists were confident that the PMIs were on the right track after the collapse of investment bank Lehman Brothers in September.
"We are retracing most of the losses that took place post-Lehman so not all indicators within the PMIs are back to the pre-Lehman levels yet but we are headed in that direction," said Jacques Cailloux at RBS.
REUTERS FORECAST: 40.5 (range 40.2-40.8, 33 forecasts)
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