China's industrial output growth dropped in November to its slowest pace in more than two years and inflation tumbled as economic conditions deteriorated, raising expectations that Beijing will pursue a more pro-growth policy to support jobs.

Easing inflation pressure on consumers at the same time as data signals a serious risk of a sharp industrial slowdown is potentially perilous for policymakers trying to engineer a soft economic landing against a backdrop of a deepening crisis in China's main export market -- debt-ridden Europe.

The sharp contraction in the real economy, the external uncertainties lingering on, plus the easing inflationary pressure all point to a larger scope for further policy easing. So the basic tone of the macro policy will lean towards the pro-growth side, said Nie Wen, analyst at Hwabao Trust in Shanghai.

A deluge of data on Friday showed China's annual consumer inflation rate tumbled in November to 4.2 percent, the lowest level since September 2010 and slightly below expectations. It was the first time since February it had fallen below 5 percent.

Inflation has dropped from a three-year high of 6.5 percent in July, allowing Beijing to shift its policy stance towards offering support for the economy, especially as CPI is now closer to the full-year government target for 2011 of 4 percent.

But it was an eye-watering collapse in producer price inflation -- down to just 2.7 percent in November, roughly half the rate of October and in outright deflationary territory month-on-month -- that has many economists anticipating a shift to a more explicit pro-growth policy.

Industrial output growth slowed sharply to 12.4 percent in November from 13.2 percent in October. The outcome was below expectations and marked the weakest pace since August 2009 during the global financial crisis, Reuters data shows, a worrying sign for the sector at the centre of China's export engine.

Factory activity, in fact, contracted in November from October, China's official purchasing managers' index (PMI) showed last week.

The risks (of a hard landing) are clearly there, said Stephen Green, an economist at Standard Chartered Bank in Hong Kong.

Retail sales in November meanwhile rose 17.3 percent from a year earlier, slightly outpacing October's 17.2 percent and confounding economists forecasting a slowdown to 16.9 percent.

For most of 2011, Beijing has been preoccupied with beating down inflation. Even with the sharp fall in November, inflation has averaged 5.5 percent so far this year, well above the government's target, so the government will be wary of tilting policy too far towards loosening.

SHIFTING POLICY

But they have offered more support to small businesses as signs of the economic slow down increased and signaled a further shift to a loosening policy on Nov 30 by cutting bank reserve requirements for the first time in three years.

Now analysts expect a further subtle shift of emphasis to supporting industry by protecting against lost jobs instead of lost consumer spending power, showing Beijing's obsession with social stability remains at the heart of policy.

A pronounced slowdown in China could lead to lay offs for millions of migrant factory workers. The Federation of Hong Kong Industries recently warned up to a third of some 50,000 Hong Kong-owned factories in adjoining Guangdong and elsewhere in China could downsize or close by the end of 2011.

Analysts expect further cuts in bank reserves to release more cash into the economy as soon as this month and cuts in interest rates in the first or second quarter of next year.

Xinhua news agency said on Friday that the Communist Party's top leaders would maintain a pro-active fiscal policy in 2012.

Reflecting Beijing's wariness about reawakening the inflation dragon, monetary policy would remain prudent, Xinhua said.

The decisions will be rubber stamped by the Central Economic Work meeting, expected next week and the biggest annual event in China's economic calendar.

The meeting is usually held in November; the delay may reflect the confusing global climate, complicated domestic challenges, and disagreement about the best policy mix. While a shift to pro-growth policy is expected, markets are focused on what exactly Beijing plans to do, Standard Chartered wrote in a note to clients after Friday's data deluge.

CONFIDENCE IN EUROPE

China's economic growth has slowed down for three consecutive quarters and economists widely expect full-year growth in 2012 to be below 9 percent for the first time since 2001 as business feels the impact of weakening demand from American buyers and Europe's festering debt crisis.

Beijing again expressed its confidence in the European Union's ability to beat the crisis at a scheduled briefing by the Foreign Ministry on Friday, even as a meeting of EU leaders met in Brussels looked set to fail to strike a straightforward deal to calm volatile global financial markets.

We're still awaiting the final outcome of the meeting. We have always stated that China has always had confidence that the EU has the ability and the wisdom to resolve the problems related to the temporary difficulties it currently faces, and that stance has not changed, ministry spokesman, Hong Lei said.

But fears of a collapse in demand from Europe are especially acute among investors worried about the impact on corporate cash flow and profits if China's biggest export market implodes.

Evidence has grown that the real economy -- especially private businesses that create most new jobs -- is being starved of affordable credit.

Those concerns in part triggered a net outflow of capital from China in October -- the first such outflows in four years -- when worries about the global economy prompted some investors to withdraw speculative funds.

The cut in bank reserves, or cash that banks must put aside, took effect on December 5, releasing between 350 billion yuan and 400 billion yuan ($55 billion to $63 billion) into the banking system.

Inflation will still be key to determine how much room the central bank has to keep cutting 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.

With average inflation this year running at 5.5 percent, any policy loosening will be measured and likely to eschew outright interest rate cuts for now, economists argue.

(Additional reporting by Kevin Yao, Zhou Xin, Langi Chiang, Koh Gui Qing, Lucy Hornby and Chris Buckley; Editing by Neil Fullick)

China Inflation