(Adds detail, analyst comment)
By David Milliken and Fiona Shaikh
LONDON, May 12 (Reuters) - British manufacturing output suffered its smallest monthly fall in more than a year in March, pointing to a possible end in sight for the sector's contraction after the worst calendar quarter since records began.
Along with news of a jump in British retail sales and a marked slowdown in house price falls, the data on Tuesday boosted hopes Britain may have passed the worst of the recession.
Official data also showed a smaller-than-expected monthly decline in the broader industrial production measure, which includes natural resources and power generation, and the narrowest goods trade deficit in almost two years.
"This continues the theme of economic recovery," said George Buckley, UK economist at Deutsche Bank. "While output is still falling, it may not be long until we see a return to growth."
Manufacturing, which accounts for just over 14 percent of British economic output, fell by a much smaller than expected 0.1 percent in March, against analysts' forecasts for a 0.8 percent decline, the slowest rate since February last year.
The ONS also revised February's figures to show a 0.3 percent decline, one-third of an earlier estimate of a 0.9 percent contraction.
Nonetheless, on a calendar quarter basis this still adds up to the worst slump in manufacturing output that Britain has seen since records began in 1948, with the sector contracting by 5.5 percent in the first three months of the year. Year-on-year, manufacturing shrank by 12.9 percent.
Industrial production, which makes up 18 percent of GDP, showed a similar pattern. Output fell 0.6 percent in March, less than the 0.8 percent forecast, and February's decline was scaled back to 0.7 percent from 1.0 percent.
This still makes it the worst 12 months for industry since monthly records began in 1968, with output down 12.4 percent. The first-quarter decline of 5.3 percent is the worst since 1974 when labour unrest caused power shortages, forcing many firms to work a three-day week.
The ONS said it did not expect the new data would of itself require a revision to its initial estimate of a 1.9 percent drop in British GDP in the first three months of the year.
"All in all, fairly positive data for the UK economy this morning," said Philip Shaw, chief economist with Investec.
"The industrial production figures are significantly better than expected and the February fall was revised sharply upwards. It appears that the industrial side of the economy wasn't as weak through the first quarter."
Sterling rose to a session high against the dollar and the euro after the data.
RETAIL, HOUSING OPTIMISM
Retail sales rose 4.6 percent on the year in April, their strongest increase in 3 years, according to the British Retail Consortium, although it warned the figures were flattered by the timing of the Easter break and warm weather.
A survey by the Royal Institution of Chartered Surveyors showed house prices fell at their slowest rate in 15 months in April.
There was also positive news from Britain's trade balance. Imports fell faster than exports in March, causing the goods deficit to fall to 6.589 billion pounds ($10.07 billion), the narrowest gap since April 2007 and down from February's downwardly revised 6.834 billion pounds.
But the improving balance reflects an overall slump in trade volumes, rather than the export growth which the government and Bank of England hope will drive Britain's recovery from its sharpest recession in 60 years.
First quarter goods exports are 16 percent lower than last year, and imports are 17 percent down.
"A decent contribution to overall GDP growth from net trade looks unlikely this year, or perhaps even next year," said economist Vicky Redwood at Capital Economics -- though she said there was stronger medium-term potential for exports.
Excluding volatile oil imports, the goods trade deficit was the smallest since September 2006, at 6.131 billion pounds -- 12 percent lower than a year ago.
Britain traditionally runs a surplus in services, which shrank fractionally to 4.052 billion pounds in March. This took the overall trade deficit down to 2.537 billion pounds from February's 2.767 billion, 28 percent less than March last year.
Sterling has fallen by a quarter against major currencies over the past year, though the ONS said it was not possible to tell if this was the reason for the smaller deficit. (Editing by Stephen Nisbet)