China's annual consumer inflation slowed sharply to a 20-month low in February, and factory output and retail sales also cooled more than forecast, giving policymakers ample room to further loosen monetary policy to support flagging growth.

Expectations that Beijing will focus on growth rather than inflation were reinforced by data confirming the world's No.2 economy is losing steam, with the consumer price index easing to 3.2 percent last month while factory output growth fell back to its lowest since July 2009. Fixed asset investment also slowed.

Easing price pressures will allow the People's Bank of China (PBOC) to continue reducing the level of cash commercial banks must hold as reserves to keep money supply steady in the face of volatile foreign capital inflows, supporting growth without causing an inflationary spike, analysts say.

The inflation story is over, economists at HSBC said in a note to clients. This leaves the PBOC with fewer excuses not to step up its easing efforts to support growth -- especially given the sharp slowdown in exports so far this year.

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China CPI food inflation: http://link.reuters.com/waf95s

China Industrial output: http://link.reuters.com/bam96s

Reuters Insider TV: http://link.reuters.com/kuk96s

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Friday's flurry of data was the first set of hard numbers of the year for industrial output, fixed asset investment and retail sales, combining data held back from January to iron out heavy distortions caused by the Lunar New Year holidays.

Factory output growth fell to 11.4 percent, below the consensus forecast of 12.3 percent, as cooling demand at home and abroad dragged production growth to its weakest since July 2009, when the world was still shuddering from the global financial crisis.

Fixed asset investment, which accounted for 54 percent of China's economic growth in 2011, grew 21.5 percent in the first two months, slightly ahead of the 20 percent forecast.

That was the lowest level since December 2002's 17.4 percent, but an encouraging sign for policymakers keen to cut dependence on investment spending for growth, which generates both over-capacity and speculative bubbles.

Retail sales grew 14.7 percent in January-February from a year earlier, short of the 17.5 percent that analysts' had expected.

The batch of data comes after Beijing sent tremors through global financial markets earlier this week by cutting its 2012 growth forecast to eight-year lows of 7.5 percent.

Although the move was made in part to make space for economic reform, it stirred worries of an abrupt slowdown or a so-called hard landing.

MORE EASING SEEN

A Reuters poll in December showed economists expected Beijing to lower banks' required reserve ratios (RRR) by 200 basis points in 2012. The central bank cut the RRR by 50 bps in February to 20.5 percent following a 50 bps cut in November.

Economists polled by Reuters had forecast China's consumer inflation to run at 3.4 percent in February from a year ago, well within Beijing's 2012 inflation target of 4 percent.

The slowdown in February's consumer inflation was mirrored by producer prices. The producer price index was shown flat on the year in February, below market expectations for prices to have quickened 0.2 percent.

Factory inflation is widely seen as a leading indicator of consumer prices, so the fact it too is losing steam bodes well for continuing moderation in consumer inflation, said Yu Song, an analyst at Goldman Sachs.

Barring a spike in world commodity prices, analysts say China's inflation should stay muted for all of 2012 as high comparison figures a year ago force food inflation to slow.

Food prices represent 30 percent of China's consumer price index, the composition of which is kept secret.

Indeed, annual food price inflation ran at just 6.2 percent in February, a low not seen since June 2010.

The further easing in the consumer price index provides more room for policy loosening, said Nie Wen, an analyst at Hwabao Trust in Shanghai. We expect the central bank may cut the reserve ratio once in March.

China's growth nationwide is on track to slow to just over 8 percent in the first quarter of the year, economists say, although they reckon the full year will see 8 to 9 percent growth, well above the official target of 7.5 percent for 2012.

Many analysts believe stability-obsessed China would pull out all the stops to keep the economy growing briskly this year as the country embarks on a crucial leadership change.

Lowering the RRR for banks would help China offset sluggish capital inflows that have been hit by skittish investors wary of investing their funds in higher-risk emerging markets at a time of global economic uncertainty driven mainly by Europe's festering debt crisis.

Crucially, an RRR cut would help Beijing meet its target of growing money supply by 14 percent in 2012.

But widespread expectations for easier policy have not fuelled bets for an outright interest rate cut. In contrast, Brazil slashed its interest rates by a surprisingly large 75 bps on Thursday to support economic recovery and restrain a strong currency that is stifling its industry sector.

The Feb CPI reading is weaker than expected due to sharp easing in food inflation, said Wang Guobing, an economist at Northeast Securities in Shanghai. But lower inflation does not mean that the central bank would rush to lose its monetary policy.

(Editing by Alex Richardson)

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