* March factory output up 1.4 pct vs Feb, misses forecasts
* Growth short of recouping 2.5 pct loss in Feb
* Imbalance between domestic demand and exports widening
SEOUL, April 29 - South Korea's factory output rebounded in March after a fall in February on robust exports but persistently depressed domestic demand underscored widening cracks in an economy that is increasingly dependent on overseas sales.
The poor performance of the domestic economy, rising inflation and growing income inequalities caused voters to turn against President Lee Myung-bak's ruling party in key by-elections this week and may prompt a cabinet reshuffle. [ID:nL3E7FR0AY]
Statistics agency data showed on Friday industrial output grew less than the market's expectations as weak domestic demand bit, with the housing market in the doldrums and the heavy household debt capping consumer spending.
"The widening gap between exports and domestic demand is a classic outcome from interventionist policy in terms of foreign exchange and central banking," said Kim Tae-dong, a popular economics professor who had served the central bank board.
The Statistics Korea data showed industrial output grew a seasonally adjusted 1.4 percent in March from February, much less than the median 1.9 percent gain forecast in a Reuters poll and far short of recouping a 2.5 percent loss in February.
Shipments of goods for domestic consumption rose only 5.1 percent in March from a year earlier against a stellar 18.0 percent jump in shipments for exports. It was the 18th month in a row that domestic shipments trailed those for exports.
For full table, double-click [ID:nL3E7FS29R].
The composite leading indicator, a guide to future economic activity, fell 0.3 percent month on month, and has been in negative territory in 13 out of the past 15 months.
"Policy agencies especially the Bank of Korea, the Financial Services Commission and the Fair Trade Commission should be freed from politics and given stronger power," said Kim, referring to the three in charge of regulatory policy.
The government has been repeatedly intervening in the currency market, imposed capital controls and said there could be more to come in a move that appears aimed at keeping the lid on gains by the won currency.
The won has risen some 6 percent so far this year against the dollar but Bank for International Settlements (BIS) data shows its real trade-weighted value stands some 8 percent below the pre-August 2008 level.
It contrasts to an about 5 percent decline in the value of the Taiwanese dollar and an almost 30 percent rise in the yen , all measured in the same trade-weighted real terms between the period, the BIS data shows.
"The Korean economy recovered strongly in 2009-10, supported by an undervalued currency, fiscal stimulus, financial supports and lower interest rates," said Young Sun Kwon, senior economist at Nomura International in Hong Kong.
"But, the inevitable side-effects are high inflation, a domestic debt overhang and income inequality," he added.
The poor domestic demand owes much to the slump in the housing market, with central bank data showing early this week the construction industry suffered its sharpest quarterly decline in 13 years during the January-March period.
Analysts said the persistent weakness in the domestic demand and the continued ultra-loose monetary policy in the advanced economies could persuade the central bank to slow the pace of policy tightening campaign that started in July last year.
"The government might do something to help ease the troubles in the real estate market but I think the central bank will feel the need to raise interest rates less (than they might have wanted)," said Yoon Yeo-sam, a fixed-income analyst at Daewoo Securities.