(Adds economist's comment, background)

By Daniel Flynn

PARIS, Sept 20 (Reuters) - French business activity took a sharp turn for the worse in September, shrinking at its fastest pace since April 2009 as weak domestic demand and a deepening slowdown in southern Europe dragged the euro zone's No. 2 economy towards contraction.

Economists suggested that the downbeat picture from France, which came against the backdrop of better-than-expected PMI figures from Germany, showed that unemployment running a 13-year high and a raft of tax rises announced by Socialist President Francois Hollande may be weighing on activity.

The Markit/CDAF flash composite purchasing manager's index (PMI), a preliminary estimate of firms' activity that covers both manufacturing and services, slid to 44.1 in September, its lowest level in 41 months, from 48.0 in August.

It was seventh consecutive month that the composite indicator remained below the 50-point threshold separating a contraction in activity from expansion.

"France is really starting to struggle quite substantially," said Markit Chief Economist Chris Williamson. "Its economy is suffering as its neighbours are seeing demand weaken and ... there are few signs of demand to stimulate growth in France."

The data suggested that France's 2 trillion euro economy, which posted zero growth in the last nine months, could shrink by as much as 0.5-0.6 percent in the third quarter, he said.

September's gloomy outlook came despite positive news flow on the euro zone crisis, including the announcement of the European Central Bank's bond-buying programme that lifted stock markets.

"It may be too early for the good news to have filtered through," Williamson said. "But the fact that businesses grew gloomier is a big concern."

Business orders, which had slowed the pace of their contraction in recent months, fell at the fastest rate in 3-1/2-years as both weak final demand and uncertainty weighed.

Hollande has made reviving France's stalled economy a priority since he took office in May but his efforts have been hampered by a wave of layoffs from companies including retailer Carrefour and car maker Peugeot.

After 7.2 billion euros in tax rises this year, Hollande has already indicated he will hike levies on households and businesses by much more in 2013 in an effort to trim France's public deficit to 3 percent of GDP.

"It could be that French-specific factors have played a role, with the upcoming fiscal consolidation of more than 30 billion euros next year likely having made consumers as well as producers reluctant to spend, hitting activity," said ABN Amro economist Joost Beaumont.

INVESTMENT SET TO FALL FURTHER

High international energy and commodity costs pushed input prices higher, while weak demand meant that output prices continued to fall, forcing companies to accept smaller profit margins.

"Investment will be hurt, as will unemployment. Companies will be moving further into cost cutting," Williamson said.

Layoffs accelerated to the fastest rate in 34 months, with manufacturers and service providers both recording steeper falls in payrolls as work backlogs declined.

The contraction in activity was most severe in the manufacturing sector, which is more exposed to the weak international outlook. Activity here fell for the seventh consecutive month, sinking to a 41-month low of 42.6.

Overall new manufacturing orders fell more sharply than export orders, suggesting that deteriorating domestic demand was mostly to blame. Household consumption, the motor of France's economy, is closely linked to unemployment, which is running at more than 10 percent.

Service activity, meanwhile, worsened for a second straight month, sliding to a four-month low of 46.1, from 49.2 in August.

Service providers' business expectations, which had improved sharply in August, slid back into negative territory in September for the first time since February 2009. The indices for outstanding business and new business in the services sector were also sharply weaker. (Editing by Jeremy Gaunt)