* Inventory, investment plunge behind Q1 GDP contraction
* Producer prices log record fall in April (Adds economists' quotes)
By Marcin Grajewski
BRUSSELS, June 3 (Reuters) - A steep drop in inventories and investment led to a record contraction for the euro zone economy in the first three months of 2009, but the depleted stockpiles raised hopes for a better performance in the second quarter.
The European Union's statistics office confirmed its earlier estimate that gross domestic product in the 16 countries using the euro fell 2.5 percent on the quarter, and revised the year-on-year contraction to 4.8 percent from 4.6 percent.
"In short, a horrendous report. Things can only get better," said Martin van Vliet, economist at ING.
Eurostat also said on Wednesday that prices at euro zone factory gates logged their biggest annual fall on record in April, pointing to negative inflation in coming months and possibly more monetary easing from the European Central Bank.
Producer prices fell 1.0 percent month-on-month and 4.6 percent annually, the biggest drop since EU measurements started in 1996 and more than expected by economists. A dip in energy costs drove the decline.
Euro zone unemployment hit a near 10-year high of 9.2 percent in April, Eurostat had said on Tuesday, just days ahead of EU parliamentary elections in which the worst economic downturn since World War Two is a major factor.
The data could prompt the ECB to consider more monetary easing, although more analysts believe the bank reached the end of the easing cycle after it cut rates to 1 percent in May.
Producer prices show inflationary pressures early in the pipeline as their moves are usually reflected later in consumer prices, which the ECB wants to grow by just under 2 percent year-on-year.
"The key challenge for ... the ECB is to ensure that the temporary period of negative inflation, resulting from lower energy and food prices, does not become embedded in people's expectations," ING's van Vliet said.
INVENTORIES TUMBLE
The main reason behind the first-quarter economic contraction was a plunge in inventories, which subtracted a full percentage point from the final quarterly result. Private investment took away another 0.9 percentage point.
But inventories will have to be rebuilt after such a steep fall, economists said. "Along with recent leading indicators, this indicates that the pace of GDP contraction should diminish markedly from Q2," said Ken Wattret, economist at BNP Paribas.
Falling household demand and negative trade on the back of exports plunging faster than imports lowered the quarterly result by 0.3 percentage point each.
The European Central Bank will release new forecasts for growth and inflation in the euro zone on Thursday. ECB Governing Council member Ewald Nowotny was quoted as saying on Wednesday they would show a sharp GDP contraction this year and growth around zero in 2010.
Economists expect the bank will forecast a contraction of 4.5 percent for 2009 against a mid-point estimate of a contraction of 2.7 percent made in March.
"The euro zone outlook still looks far from bright and we suspect that sustainable recovery is unlikely to develop until 2010," said Howard Archer, economist at IHS Global Insight.
"Sharply rising euro zone unemployment is a particular threat to recovery hopes, while global economic activity and trade is still depressed despite some signs of recent improvement," he said.
Eurostat confirmed that Europe's biggest economy, Germany, led the economic plunge in the first quarter with a 3.8 percent quarterly fall and a 6.9 percent annual drop.
France, Europe's second-biggest economy, had a fall of 1.2 percent on the quarter and Italy, the next biggest economy, had a drop of 2.4 percent.
In the wider 27-nation European Union, GDP shrank by 2.4 percent quarter-on-quarter and 4.5 percent annually as non-euro country Poland posted modest growth.
Economies in the Baltic republics, worst hit by the crisis, contracted by 18.6 percent year-on-year in the case of Latvia, 15.6 percent in Estonia and 11.8 percent in Lithuania. (Additional reporting by Jan Strupczewski; Editing by Dale Hudson)