(Adds comment from Italian employers' association, ECB President Trichet, German economy minister)
By James Mackenzie
PARIS, May 11 (Reuters) - Industrial production in France and Italy dropped more sharply than expected in March, suggesting the eurozone economy will record a severe contraction in the first quarter before the outlook brightens.
Coming after recent more positive business confidence surveys and pronouncements from policymakers that the worst of the crisis may have passed, the data underlined the gravity of the situation facing European manufacturers.
Italian seasonally adjusted output tumbled 4.6 percent in March from the previous month and on a work day-adjusted basis dropped 23.8 percent year-on-year, the heaviest fall since the series began in 1990, statistics office ISTAT said.
In France, output was down 1.4 percent from the previous month and production in the first three months of the year was 15.5 percent below the level of the same period last year, French statistics agency INSEE said.
In both countries, the monthly declines were more than twice as steep as economists had been expecting and contrasted with an unexpected stabilisation in industrial production reported last week in Germany, the euro zone's biggest economy.
France and Italy both saw falls in manufacturing, which represents the bulk of the index, and energy output but analysts noted that the pace of the fall had slowed in France after severe slides in previous months.
Greece also reported a decline in March output, which fell 5.3 percent year-on-year.
With recent business confidence and purchasing managers' surveys showing tentative signs of improvement, Monday's data complicates the picture for gross domestic product and eurozone industrial output figures out this week.
"The improvement we've seen in the business surveys has not yet translated into hard data and I think we couldn't really have expected it to do so that quickly," said Laurent Bilke, chief European economist at Nomura in London. "It's more a story for the middle or the end of the second quarter than for the month of March which is definitely too early to see," he said.
INFLECTION POINT?
European Central Bank President Jean-Claude Trichet has been among those seeing signs of a turnaround, saying on Monday that Europe was "around the inflection point" in the growth cycle.
German Economy Minister Karl-Theodor zu Guttenberg also sounded an optimistic note, saying Germany should bottom out towards the end of the year.
But the manufacturing weakness in the euro zone's big three economies will weigh heavily on industrial production figures for the whole of the 16-nation bloc on Wednesday, when analysts expect a 1.0 percent monthly fall and an 18 percent annual drop.
Monday's weaker output figures will also reinforce expectations for a sharper contraction in gross domestic product during the first quarter with the economy firmly stuck in the worst recession since World War Two.
Germany, France, Italy and the eurozone as a whole all report GDP figures on Friday and the impression was growing that the figures would be even worse than last year's fourth quarter, when euro zone GDP shrank 1.6 percent.
French Economy Minister Christine Lagarde said France's numbers would be "undoubtedly bad", while Italy's Confindustria employers association said it expected GDP to contract by more than 2 percent in light of the output data, compared with analysts' forecasts for a 1.8 percent fall.
"Euro-zone industrial production probably undershot expectations in March," analysts from Capital Economics wrote in a research note following the French and Italian data.
"In turn, this suggests that risks to the first quarter euro-zone GDP figures, which are out later this week, are skewed to the downside relative to the median forecast of 2.0 percent." (For a story looking ahead to the eurozone GDP data, please double click on)
Both the production and GDP data are backward-looking indicators and improved survey data has fed the hopes that the worst of the crisis may have passed, but Monday's data underlined warnings against too much optimism.
"It is falling less quickly, but we are still in that context, and that will force everyone to confront a reality which is a bit less rosy than what the markets have incorporated rather quickly," Olivier Gasnier, an economist at Societe General in Paris said of the French output data. (Additional reporting by Daniel Flynn in Rome; Editing by Toby Chopra)