* German economy slows drastically on euro zone crisis
* Budget swings to surplus for first time since 2007
* Government seen halving 2013 growth forecast to 0.5 percent
The German economy was hit hard by the euro zone crisis in the final quarter of last year, shrinking more than at any point in nearly three years as traditionally strong exports and investment slowed, the Statistics Office said on Tuesday.
Economists expect Germany to bounce back after forecasts for weak growth in the first quarter but Europe's largest economy will be less of a pillar of support for the rest of the currency bloc, where many of its peers are deeply in recession.
"The German economy might not be an island of happiness any longer but it remains at least an island of growth in a still recessionary euro zone sea," said ING economist Carsten Brzeski.
Gross domestic product shrank by 0.5 percent in the final three months of 2012, the worst quarterly performance since Germany fell into a recession during the global financial crisis in 2008/2009 and only the second contraction since it ended.
The parlous fourth quarter pushed overall growth for the year down to 0.7 percent, a sharp slowdown from the 3.0 percent registered in 2011 and a post-reunification record of 4.2 percent in 2010. The 2012 figure was a tad below a Reuters consensus forecast for growth of 0.8 percent.
The government is due to publish an estimate for 2013 growth on Wednesday. An official from the Economy Ministry said growth would be 0.4 percent this year, less than half the government's existing forecast of 1.0 percent.
So far unemployment remains low and wages are likely to rise again this year, but if ordinary Germans were to feel the pinch of the euro crisis in an election year, it could hurt popular centre-right Chancellor Angela Merkel's hopes for a third term.
As the economy slowed in the second half of 2012, consumers have already lost some will to spend. Household spending grew 0.8 percent in 2012, down from 1.7 percent in 2011 and consumer sentiment dropped to its lowest level in more than a year going into January.
German exports and imports slid in November and industry orders fell more than expected -- confirming the weak end to the year, although more recent survey evidence suggests a moderately better start to 2013.
For the full year, export growth slowed to 4.1 percent from 7.8 percent in 2011, while equipment investment fell by 4.4 percent, the Statistics Office said.
"In the previous two years, GDP growth had been much larger but that was due to a catching-up process after the worldwide economic crisis of 2009," said Roderich Egeler, head of the Statistics Office, adding the economy had been robust overall.
Andreas Scheuerle of Dekabank said the 2012 figure was "disappointing" at a first glance.
"But if you take the tough environment in the euro zone and weakness in growth markets into account, one can be quite pleased after all," he said.
German companies and economic data have sent mixed signals of late.
Deutsche Post has said it expects that 2013 will "not be easy" as a weak global economy weighs on demand for express delivery and other logistics services.
And luxury carmaker BMW has said its home market may weaken in 2013.
There are however signs that Europe's largest economy, may emerge soon from the year-end contraction.
The country's private sector expanded for the first time in eight months in December and business morale climbed in the same month to the highest level in five months on an improved outlook, which points to Germany being able to avoid a recession -- defined as two consecutive quarters of contraction.
FIRST SURPLUS SINCE 2007
Despite the slowdown, a still strong labour market and rising wages helped Germany swing to its first public sector budget surplus in five years.
The Statistics Office said the federal government, states, communities and social insurance together produced a small surplus of 0.1 percent of GDP.
Economists noted this was not due to efforts by Merkel's government, which has pressured other euro zone countries to cut spending and embark on tough structural reforms to boost Europe's competitiveness and reduce debt.
"Increasing employment and firms' strong earnings have made this possible, not the state's spending restraint," said Joerg Kraemer of Commerzbank.
The government also met its "debt brake" rule -- a legal commitment to cut its structural deficit to no more than 0.35 percent of GDP -- four years ahead of time, a finance ministry official said. Structural net new borrowing came in at 0.32 percent of GDP.
Clemens Fuest, incoming head of ZEW research institute, said there was a risk the surplus would prompt the government to raise spending at a time when budget consolidation was needed.
"The second risk comes from the economy, which is doing much worse than expected," Fuest told Reuters. "The situation is significantly worse than the mood. But the euro zone crisis is far from over. It's wishful thinking to expect otherwise."