UPDATE 1-China Dec factory activity shrinks for 10th month-Caixin PMI

(Adds economists’ outlook, background, official PMI on Friday)

* Factory activity contracts for 10th, pace of fall quickens

* Caixin factory PMI falls to 48.2 in Dec vs Nov’s 48.6

* Output drops to 48.7 after neutral reading in Nov

* Employment contracts for 26th month

BEIJING, Jan 4 (Reuters) - China’s factory activity contracted for the 10th straight month in December, and at a sharper pace than in November, a private survey showed, dampening hopes that the world’s second-largest economy will enter 2016 on steadier footing.

The Caixin/Markit China Manufacturing Purchasing Managers’ Index (PMI) slipped to 48.2 in December, below market expectations for a slight pick-up to 49.0 and down from November’s 48.6.

The reading was the lowest since September, remaining well below the 50-point level which demarcates contraction from expansion on a monthly basis.

The survey focuses more on small and medium-sized private firms. An official survey on Friday, which looks at larger state-owned companies, showed a fifth month of contraction though at a slightly more modest pace of 49.7.

Both surveys pointed to a continued albeit gradual loss of momentum, not a sharper deterioration or “hard landing” which has been feared by global investors. Plus, a stronger services sector is cushioning some of the downdraft from factories.

Still, economists expect more interest rate cuts, reductions in banks’ reserve requirements and other stimulus in 2016 as the economy has been unusually slow to respond to a year-long flurry of support measures, suggesting it is facing deeper-rooted cyclical and structural challenges than in the past.

The government is expected to increase its budget deficit to about 3 percent of gross domestic product in 2016 to help boost activity.

Weighed down by weak demand at home and abroad, factory overcapacity and cooling investment, China is expected to post its weakest economic growth in 25 years in 2015, with growth seen cooling to around 7 percent from 7.3 percent in 2014.

Some market watchers suspect real growth is actually much lower than official data suggest.

“We are reviewing our 7.0 percent forecast for fourth-quarter 2015 GDP growth for downward revision,” ING said in a research note on Monday ahead of the PMI survey.

“Absent vibrant external demand, we think it’s a consensus view that China’s GDP growth is poised to slow further to ‘about’ 6.5 percent in 2016.”

Beijing’s progress on reforms may also be a key risk factor this year, after its surprise yuan devaluation in August and heavy handed stock market rescue in summer raised questions about its ability to enact market liberalisation steps that are a centrepiece of its economic agenda.

After picking up for the first time in seven months in November, the Caixin PMI output sub-index dropped to 48.7 in December, its lowest in three months, with anecdotal evidence suggesting firms had cut output due to weaker demand.

As companies cut costs and downsized, employment was also hit, falling to 47.3 in December, the 26th month in a row that employment has contracted.

New export orders contracted after two months of expansion, pointing to a weak start in 2016. Total new orders shrank for a sixth month, highlighting weak domestic demand as well.

Top leaders at the recent annual Central Economic Work Conference pledged to make monetary policy more flexible and expand the budget deficit in 2016 to support the economy as they seek to push “supply-side reform”.