* China consumer inflation in Nov drops to 4.2 pct
* Below forecast of 4.4 pct and down from 5.5 pct in Oct
* Producer prices up 2.7 pct, versus forecast of 3.3 pct
* Weaker inflation gives central bank room to loosen
* Data due later includes industrial output, retail sales
By Lucy Hornby and Kevin Yao
BEIJING, Dec 9 (Reuters) - China's annual inflation rate tumbled in November to 4.2 percent, the lowest level in more than a year, fuelling expectations of further monetary policy easing to combat deteriorating domestic and international economic conditions.
The rate has dropped rapidly since hitting a three-year high of 6.5 percent in July and is now at a pace closer to the full-year government target for 2011 of 4 percent.
That leaves room for Beijing to push through further cuts in bank reserves to free up cash for lending, analysts say, but policy loosening will be measured for fear of reigniting inflationary pressures.
"It's clear now that China's inflation is easing, and the process of easing is faster than expected," Wang Guobing, an economist with Northeast Securities in Shanghai said. "But it's still too early to say that China will turn to a full and complete policy relaxation," he said.
"Inflation will hover around 4 percent in the coming months, and the government still has to seek a balance between growth and inflation control," Wang added.
That balance will be tough to strike because inflation so far in 2011 has averaged 5.5 percent, even though the November rate was the first below 5 percent since February and the lowest since September 2010.
But analysts -- who had forecasts in a tight range of 4.2-4.6 percent in the benchmark Reuters poll to deliver a consensus call of 4.4 percent -- eye the risk of a rapid cooling of the economy as signalled by an even starker fall in the rate of producer inflation.
"Inflation is marching south at an aggressive pace, with the producer price inflation virtually collapsing -- down to just 2.7 percent year on year, almost half of that last month and tumbling into deflation in month-on-month terms at minus 0.7 percent," said Alistair Thornton, an economist at IHS Global Insight in Beijing. Producer inflation in October was 5 percent.
"Warning signs of this sharp trend have been evident in the buy-up price sub-index of the PMI, highlighting strong downward pressure on prices amid an increasingly gloomy global outlook."
China's HSBC purchasing managers' index on manufacturing dropped to a 32-month low in November, suggesting sector activity was shrinking. Its various sub-component indexes suggested demand was weaker at home than abroad.
Hua Zhongwei, an economist at Huachuang Securities in Beijing, reckons the data shows China's policies have to shift to a pro-growth bias in a stronger and quicker way.
Inflation running well above the government's target had forced Chinese planners to keep monetary policy tight, even as evidence grew that the real economy -- especially private businesses that create most new jobs -- was being starved of credit at affordable rates.
But moderating price pressures, as well as easing money supply pressure, allowed the People's Bank of China on the last day of November to announce a cut in the ratio of reserves banks must hold, a clear signal of a policy shift after a two-year tightening campaign.
It was the first RRR cut in three years and came into effect on Dec 5, releasing between 350 billion yuan and 400 billion yuan ($55 bln to $63 bln) into the banking system.
"We expect the central bank to lower the RRR four more times next year," said Dongming Xie, an economist at OCBC Bank in Singapore.
Inflation rates will help determine how much room the central bank has to further cut reserve rates and unleash up to 16 trillion yuan tied up in the banking system.
China's government -- which ultimately sets monetary policy -- is constrained by inflation as rising prices have a history of spurring social unrest. A big injection of cash could easily reignite sharp price rises.
Market showed no specific reaction to the Chinese data as investors focused on an EU summit meeting in Brussels aiming to map a way out of the euro-zone debt crisis. The euro, U.S. stock futures and the Australian dollar fell on disappointment at the headlines emerging from the meeting.
Other Chinese data due later on Friday, including industrial output and retail sales, is expected to demonstrate the slowdown in the domestic economy, which bodes ill for China's efforts to turn to its home market as European and American demand for its exports weaken.
Annual retail sales growth is estimated to have weakened to 16.9 percent in November from 17.2 percent in October and 18.7 percent in November 2010.
Industrial production growth likely slowed to 12.8 percent from more than 13 percent in data the month before. The country's official purchasing managers' index showed that factory activity in November shrank from October.
The softening in producer price pressures comes despite stronger oil prices, which are about 15 percent higher in dollar terms now than they were a year ago.
By contrast, the price of iron ore, a commodity whose value has been primarily driven by China's gargantuan demand for steel over the past decade, is down by over 20 percent compared with a year ago.