* May factory output, investment surprisingly strong
* July manufacturing business confident at 13-month high
* Private export outlook index rises after 1-year slump
* Investors price in higher chances of an interest rate rise (Adds details, analyst comment)
By Yoo Choonsik and Seo Eun-kyung
SEOUL, June 30 (Reuters) - South Korean factory output rose more than expected and capital investment surged in May while confidence among manufacturers toward July jumped, raising chances for an early interest rate increase.
Treasury bond futures slid whereas the won rose as investors took these and other indicators released on Tuesday as lifting the chance for the central bank starting to raise interest rates over the coming months.
Although the outlook remained uncertain because many advanced economies are still in recession, analysts said these indicators cemented their view that Asia's fourth-largest economy was on a solid recovery path.
"Provided the economic recovery follows the normal pattern, the likely scenario is that the Bank of Korea will send some signals for a change in monetary policy around the fourth quarter and raises interest rates some time in the first half of next year," said Chang Hwa-tak, an economist at Dongbu Securities.
South Korea could be one of Asia's economies that will outperform developed markets if exporters can capitalise on rebounding growth in China -- its biggest foreign market -- to escape sluggish U.S. and European markets.
The National Statistical Office said the industrial output index extended its gaining streak to a fifth straight month in May by rising a seasonally adjusted 1.6 percent from April, above expectations for a 0.4 percent gain in a Reuters poll.
The agency also said an index measuring the value of investment in factories jumped a seasonally adjusted 16.7 percent in May from April, the fastest in nearly 13 years that also reversed a 7-month losing spree.
EXPORTS TO GATHER PACE
Analysts said it was premature to assess the effect from the increased investment because that follows unusually steep reductions in such spending and as most of the spending in May was apparently meant to make up for lost maintenance work.
Economists at Citigroup said they were cautious about the investment rebound because it could be "a one-off given the remaining uncertainties in the global economic outlook".
Nomura International on Tuesday upgraded its view on South Korea's economy to a GDP contraction of 1 percent this year from a drop of 4 percent previously.
September treasury bond futures lost 24 ticks, or nearly a quarter of a percent, to end at 109.43 while the won gained almost 1 percent against the dollar as investors increased bets on an accelerating economic recovery.
A drop in the inventories-to-shipments ratio to a 17-month low in May meant production was growing even as companies have yet to begin restocking their depleted inventories, suggesting production could grow faster rather than weakening.
The central bank said on Tuesday its seasonally adjusted business survey index for July rose for a fourth straight month to a 13-month high, while the economy ministry's similar index for the third quarter hit the highest in five quarters.
South Korean exporters also expect improving prospects as a measure of export prospects released by a state-run bank specialising in trade financing turned higher for the first time in a year for the third quarter.
The data came a day before the Ministry of Knowledge Economy is due to release export and import figures for June on Wednesday as the first big exporting economy in the region.
Economists surveyed by Reuters had forecast the pace of annual decline in South Korean exports would slow in June from May on the back of a still weak won and recovering demand mainly from the emerging economies.
In its strongest economic assessment since September last year, the Bank of Korea, the central bank, said early this month the slide in the economy has probably halted.
The remarks, along with the central bank's warning comments on inflation, have raised speculation that interest rates were set to rise soon.
The Bank of Korea held the 7-day repurchase agreement rate steady at a record low of 2.0 percent for the past four months in a row after reductions totalling 3.25 percentage points since October last year. It next reviews the rate on July 9. (Editing by Jan Dahinten)