By Michael Nienaber

BERLIN (Reuters) - Germany's domestic economy is set fair for further growth, with robust household and government spending propelling a self-reinforcing cycle of activity, though Britain's Brexit vote has unnerved German companies trading abroad.

Data and surveys released this week showed domestic demand cementing its role as the main driver of Europe's biggest economy, more than compensating for a sluggish export sector that is facing waning demand.

A robust labor market, rising wages and ultra-low borrowing costs suggest the spending power of German consumers will rise further, the GfK sentiment indicator showed on Friday.

The survey showed the consumer mood improved unexpectedly heading into September, hitting one of its highest points in the past 15 years.

That reinforced expectations that private consumption, along with state spending, will drive an economic expansion tipped to reach 1.7 percent in 2016 - a forecast that could well be bumped higher.

The GfK institute said it expected private consumption, which accounts for roughly 50 percent of GDP, to grow by 2 percent.

"There are still no signs of consumer fatigue in Germany," said Sal. Oppenheim economist Ulrike Kastens. "Private consumption remains an important pillar for the German economy, in addition to construction."

BUDGET SURPLUS

But an unwillingness to invest on the part of companies - which Kastens termed the economy's Achilles' heel - remains a barrier to faster growth.

The private sector is holding back investment due to a number of external risks and uncertainties, not least the timing and terms of negotiations between Brussels and London on their future relationship.

German exports to Britain - its third biggest market - stagnated in the first half of the year ahead of the 23 June referendum in which Britons voted to leave the European Union.

Brexit-related risks were a major factor in a sharp and unexpected drop in morale among German company executives in August, as measured on Thursday by the benchmark Ifo index.

Even so, Tuesday's survey among purchasing managers by research firm Markit - also closely watched - showed German private sector growth remained robust overall.

That points to further expansion in an economy that grew a robust 1.1 percent in the first half of the year.

The solid upswing generated a record budget surplus over the same period, allowing Finance Minister Wolfgang Schaeuble to increase state spending on roads, housing and migrants ahead of federal elections in 2017, while sticking to his goal of running a balanced budget.

Some analysts now think economic growth will pick up speed in the third quarter, to 0.5 percent from 0.4 percent in the second.

For 2016 as a whole, the government and national central bank expect GDP to expand by 1.7 percent, matching last year and the strongest growth rate in four years.

Chancellor Angela Merkel's chief of staff Peter Altmaier has hinted Berlin may nudge that forecast higher, saying in June: "We will have economic growth this year that is probably above last year's level."

(Reporting by Michael Nienaber, editing by John Stonestreet)