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* UK budget deficit much lower than forecast in February
* Retail sales jump 2.1 pct on the month after snowy January
* Factories upbeat, economists see lower chance of recession
By David Milliken and Christina Fincher
LONDON, March 21 (Reuters) - Britain ran asmaller-than-expected budget deficit in February and retailsales rebounded, data showed on Thursday, a fillip for financeminister George Osborne a day after he released dismal economicforecasts.
The Confederation of British Industry also reported thatmanufacturers expect the strongest growth in output since lastApril over the next three months.
Deficit reduction is the key economic policy of Britain'sConservative-led coalition government, which came to power inMay 2010 when Britain's budget deficit exceeded 11 percent ofannual economic output - one of the highest for a major economy.
Weak growth has plagued the government's budgetconsolidation plans, but retail sales figures released at thesame time as the borrowing figures suggested at least sometemporary relief after a dismal January for retailers.
The government's preferred measure of Britain's publicborrowing, which strips out some of the effects of its bankbailouts, showed a deficit of just 2.8 billion pounds ($4.2billion) in February, the Office for National Statistics said.
This is the lowest deficit for February in the last fiveyears - albeit one flattered by one-off factors and signs thatsome payments may have been pushed into the next financial year- and is far below average market forecasts of an 8.45 billionpound deficit.
With just one month of the fiscal year to go, borrowing forthe year to date now totals 94.9 billion pounds, excluding aboost from April's transfer of Royal Mail pension assets.
This puts Osborne on track to undershoot an upwardly revisedforecast of 114.5 billion pounds for 2012/13 - equivalent to 7.4percent of gross domestic product - released on Wednesday bygovernment forecasters at the Office for Budget Responsibility.
Sterling rose to a two-week high against the dollar and afive-week high against the euro after the data.
"It's mildly encouraging and we can see why sterling ralliedon the back of that news," said Tom Vosa, economist at NationalAustralia Bank. "Public sector borrowing now looks to be in linewith stronger employment growth."
TOUGH OUTLOOK
However the economic outlook is still tough. Wednesday'supward revision to borrowing forecasts was accompanied by adowngrade to the 2013 growth forecast to just 0.6 percent - halfDecember's prediction - and prospects for British export marketsin the euro zone are even worse.
Many economists still believe the economy is at risk oftipping into its third recession in four years - even ifThursday's retail sales data make this less likely.
Retail sales volumes jumped by 2.1 percent in February -their biggest rise since March last year and much more thaneconomists forecast - and are 2.6 percent higher on the year.
A bounce back from a snowy January and strong demand fortablet computers, sports goods and jewellery helped sales, thestatistics office said.
Still, there were signs of weakness in the retail sector.Next, Britain's second-biggest clothing retailer, saidtrading in its new financial year had been slow.
February's strong public borrowing figures are explained bya mix of factors - many of which are not set to last.
A 2.6 billion pound transfer of cash from the Bank ofEngland under a deal to return gilt interest to the government,and 2.3 billion pounds from the sale of next-generation mobilephone frequencies flattered the data.
Government departments' spending fell and tax receipts wereup 9 percent on the year in February, outpacing a 2 percent riseseen over the tax year as a whole.
However, economists warned that the drop in governmentdepartments' spending was due in some cases to postponingpayment of bills until the new financial year starting in April.
"It's likely that we'll see stronger spending next year andhopefully stronger receipts as well. But the upshot of it is weshouldn't expect the strength evident in these numbers tocontinue. I think next year will be a struggle," saidPeter Dixon, an economist at Commerzbank.
With growth weak, the government only aims to reduce itsbudget deficit to 6.8 percent of GDP in the 2013/14 tax year. That compares with 3.7 percent for 2013 in neighbouring France, which has been criticised for missing its targets.
