By Gavin Jones and Stefano Bernabei
ROME, July 4 (Reuters) - Italy's recession-bound economy should begin to recover from the end of this year but its growth outlook remains weak and Enrico Letta's government must accelerate its reform efforts, the International Monetary Fund said on Thursday.
At the end of annual consultations with Italy, the IMF said the euro zone's third largest economy would contract by 1.8 percent this year, worse than its previous projection of a 1.5 percent fall in output.
Next year will see growth of 0.7 percent, the Fund said in its concluding statement, up from its previous forecast of 0.5 percent, but it warned that the risks to its outlook are tilted to the downside and market sentiment remains fragile.
Italy's reform efforts need to be complemented at the European level, the Fund said, urging direct asset purchases by the European Central Bank and more long-term cheap loans 'of considerable tenor' to euro zone banks.
Italy is mired in its longest post-war recession, with gross domestic product shrinking for seven consecutive quarters since the middle of 2011 and unemployment at a record high above 12 percent.
The IMF said it expected the recession to end towards the end of this year, supported by exports.
Recent data has been mixed, with some signs of revival in the manufacturing sector but a persistent slump in construction, retail and services, as domestic demand remains extremely weak.
'Accelerating the momentum for reform will be essential to jumpstart growth and create jobs,' the IMF said.
'Europe will also need to play its part with actions to address financial fragmentation and strengthen further the currency union,' it added.
Italy has been euro zone's most sluggish economy for more than a decade. After years of stagnation and recession its gross domestic product is lower now, in inflation-adjusted terms, than it was at the end of 2001.
'Italy's growth prospects over the medium term will strengthen only with the implementation of comprehensive reforms,' the IMF said.
It said reforms adopted by Italy in recent years did not go far enough and called for greater deregulation of the service sector and the labour market and reform of a 'lengthy and inefficient' justice system.
It urged a single, more flexible labour contract for new workers and said Italy should accelerate its stalled privatisation programme.
Italian authorities must also closely monitor Banca Monte dei Paschi di Siena's restructuring plan and be ready to act if Italy's third-largest lender misses its financial targets, the Fund said.
(Additional reporting by Giuseppe Fonte; editing by James Mackenzie and Stephen Nisbet) Keywords: ITALY IMF/
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