* Weak investment output weighs
* Ministry sees poor third quarter production
* Figures signal German economy loosing steam (Adds background)
By Annika Breidthardt
BERLIN, Oct 7 (Reuters) - German industrial output in August plunged at its steepest rate since the height of the financial crisis, data showed on Tuesday, while the International Monetary Fund cut its German growth forecast.
Combined with Monday's tumbling industrial orders, the news raised further concern that Europe's largest economy is running out of steam.
The 4.0 percent month-on-month drop in industrial production missed a consensus forecast in a Reuters poll for a 1.5 percent decrease and even the lowest forecast for a 3.0 percent fall. It was the biggest drop since a 6.9 percent fall in January 2009.
Germany's economy had a strong start to the year but shrank by 0.2 percent in the second quarter. Evidence is mounting that it barely grew in the third quarter and some economists even forecast it may have contracted again.
The IMF cited a slower-than-expected recovery of domestic demand as it cut its growth outlook. It now sees 2014 growth of 1.4 percent, down from its 1.9 percent forecast in July. It also cut its 2015 forecast to 1.5 percent from 1.7 percent.
"The economic dynamism has come to a halt in Germany," said Ulrike Kastens of Sal. Oppenheim, who believes the economy may have contracted slightly in the third quarter.
The poor data comes when pressure is mounting for Germany to use its healthy budget to boost public spending and spur growth in Europe. But Finance Minister Wolfgang Schaeuble rejects such demands and is likely to reaffirm his stance at the annual meeting of World Bank and IMF in Washington this week.
It is "an illusion that we can solve our problems using more and more public funds and ever higher deficits", Schaeuble told parliament when presenting the 2015 budget last month.
German Chancellor Angela Merkel's government says it has little wiggle room for stimulus given its promise to balance the federal budget next year, and has attempted to move the focus to private investment. But the IMF said Berlin needed to do more.
"Germany, which has completed its fiscal consolidation, could afford to finance much-needed public investment in infrastructure primarily for maintenance and modernisation, without violating fiscal rules," the IMF said.
"Large negative growth surprises in euro area countries should not trigger additional consolidation efforts, which would be self-defeating."
An 8.8 percent drop in the production of investment goods weighed on the overall figure, as the automotive industry drove down its production by a quarter during the summer holiday.
The Economy Ministry said the extent of the fall was exacerbated by holiday effects but forecast that production would be weak in the quarter as a whole.
The poor production data comes on the heels of the deepest drop in industrial orders since 2009 in the same month and a slew of weak sentiment indicators reflecting low demand from abroad and uncertainty over the Ukraine conflict.
German output data for July was also revised downwards to a 1.6 percent increase from a previous 1.9 percent rise.
(Additional reporting by Stephen Brown, Klaus Lauer and Rene Wagner; Editing by Stephen Brown Editing by Jeremy Gaunt)