* FTSEurofirst 300 down 0.7 pct, reverses two-day rebound
* Grim German data fuels worries over economic outlook
* Rio jumps after rejects merger approach by Glencore
By Blaise Robinson
PARIS, Oct 7 (Reuters) - European shares fell in early trade on Tuesday after German industrial output fell far more than expected, but losses were limited by gains in mining shares after Rio Tinto rejected a merger approach from rival Glencore.
At 0755 GMT, the FTSEurofirst 300 index of top European shares was down 0.7 percent at 1,341.44 points. The benchmark index had gained 1.1 percent over the past two sessions.
"Volatility has surged again in Europe, but there's no clear trend in terms of direction," Aurel BGC analyst Gerard Sagnier said. "It's better to move to the sidelines for now. Investors need to be patient, the bullish trend will resume at some point."
Bucking the market, Rio Tinto surged 5.5 percent after it said it had rejected a merger approach from smaller rival Glencore that would create a $160 billion mining and trading giant.
The news sparked hopes of consolidation in the basic resources sector, recently hurt by a slump in metal prices including iron ore, which has hit five-year lows. The STOXX basic resources sector index has lost 12 percent since late July.
Shares in Anglo American added 2.1 percent on Tuesday and BHP Billiton gained 1.1 percent. Glencore was up 0.6 percent.
Shares in Cairn Energy, meanwhile, surged 10 percent after the oil explorer said it had discovered oil at a well in a previously untapped area off the coast of Senegal.
Europe's main indexes were all down, however, with UK's FTSE 100 index off 0.6 percent and France's CAC 40 down 0.7 percent. Germany's DAX index lost 0.8 percent.
RWE was down 1.3 percent, Siemens down 1.2 percent and Commerzbank down 1.3 percent.
Before the opening bell on Tuesday, Germany reported its biggest drop in industrial production since the financial crisis in early 2009, the latest figures to raise question marks about Europe's biggest economy.
Germany's economy had a robust start to the year, but then it shrank by 0.2 percent in the second quarter, and a recent batch of poor data has fuelled expectations that it barely grew in the third quarter.
Germany's DAX, the euro zone's best-performing stock market in the five years since Lehman Brothers collapsed, has been lagging all other major European markets so far this year, down 4.4 percent. link.reuters.com/pap87v
Europe bourses in 2014: link.reuters.com/pap87v
Asset performance in 2014: link.reuters.com/gap87v
Today's European research round-up (Editing by Hugh Lawson)