UPDATE 3-Germany exits recession, prospects brighten

* Germany exited recession in Q2, official data confirm

* Private consumption and net trade boost growth

* Inventories fell sharply, raising hopes of a rebound

* Government stimulus cited as reason for recovery

BERLIN, Aug 25 - Germany exited recession in the second quarter despite a massive drop in inventories and restocking by firms could spur the economy to faster growth.

Federal Statistics Office data confirmed on Tuesday that gross domestic product (GDP) grew by 0.3 percent in April-June period, as net trade and private consumption offset the reduction in firms' inventories.

The data ended four straight quarters of contraction, and could offer support for Chancellor Angela Merkel's ruling coalition as a federal election approaches on Sept. 27.

Having overcome its deepest slump since World War Two, analysts believe the German economy should rally as companies ramp up production and rebuild their depleted stocks.

"The big decline in inventories suggests that these need to be built up again and that production will get a boost," said Juergen Michels, an economist at Citigroup in London. "The recovery has a relatively solid foundation."

Government stimulus measures, such as a subsidy for scrapping old cars in exchange for newer, more environmentally friendly models, were seen by many as a key driver of growth in the April-June period.

"Despite today's positive numbers, the German economy is still on a drip, getting infusions from policymakers," said Carsten Brzeski, an analyst at ING Financial Markets.

"The coming weeks and months look good but some doubts remain whether the economy can already stand on its own feet."

The figures showed that adjusted for working days, German GDP contracted by 5.9 percent on the year in the second quarter, confirming preliminary estimates from Aug. 13. In the first quarter, it shrank by 6.7 percent.

Many analysts believe job losses in Germany will accelerate in the autumn as the effects of government support for the labour market -- notably incentives for firms to put workers on shortened hours rather than fire them -- wear off.

In a breakdown of the data, the Office said net trade added 1.6 percentage points to GDP as a sharp drop in imports outpaced a decline in exports. Private consumption added 0.4 points and a liquidation in inventories subtracted 1.9 points.

RISING EXPECTATIONS

Since Germany reunified in 1990, inventories had only once hit GDP harder, an Office spokesman said.

Then, in the last quarter of 2006, the blip was caused by statistical factors, and did not properly reflect the state of the economy at the time, he added.

Latest indicators, such as the Ifo institute's gauge of business sentiment, have risen, suggesting the recovery is gaining strength. Measures of analyst and investor confidence have also risen steadily in recent months.

"Business expectations among firms have improved palpably in the summer, albeit from a low level," said Volker Treier, chief economist at the chamber of industry and commerce (DIHK).

"This points to growth in the second half of the year -- which means we could be looking at a statistical overhang of one percent for 2010," he added.

Such an overhang would imply GDP growth of 1 percent even if the economy stagnated quarter-on-quarter throughout the year.

Nevertheless, worries about a possible credit crunch persist, and the German Economy Ministry says it has been examining steps it could take to counter this.

Not all economists believe that the German economy has benefited inordinately from state support.

"In our view, the turnaround has little to do with the fiscal stimulus packages implemented by (Merkel's) grand coalition," said Andreas Rees at UniCredit.

"Instead, private consumption rose due to declining inflation rates. The increase in construction activity can be mostly related to a catching-up process after the weather-related stagnation at the beginning of the year."