* Iron ore index slumps to lowest point since Dec 2009
* Steel output cuts unlikely to support iron ore price
By David Stanway
BEIJING, July 27 (Reuters) - Benchmark international iron ore prices hit their lowest level in more than two and a half years on Friday as China's slowing economy reduced global demand growth.
The fall in the price of iron ore cargoes to the world's biggest steelmaking country will trigger alarm bells among global iron ore giants such as Vale, BHP Billiton and Rio Tinto , all targeting growth in Chinese demand with rapid capacity expansion plans.
The Steel Index's price for 62 percent-grade iron ore grade for delivery to China hit $116.20 per tonne on Friday, its thirteenth consecutive decline and the lowest since Dec. 29, 2009. The steel ingredient has declined 7 percent in a week.
China's economic slowdown is exacerbating the annual summer lull for the country's steel industry, when soaring temperatures and frequent storms reduce construction activity.
Falling prices have already hit the revenues of the top mining companies. Brazil's Vale, the world's biggest iron ore producer, posted its worst earnings results in two years on Thursday, with second-quarter profits down 58 percent as a result of slowing iron ore demand.
Iron ore prices are around $50-60 per tonne cheaper than the same period last year and analysts said the situation could worsen.
"Iron ore prices could go into free-fall until end-user demand for steel picks up in the autumn," said Rafael Halpin, China analyst with the UK consultancy MEPS.
China's downturn has cut real estate investments and eroded demand in downstream sectors such as automobiles, shipbuilding and household appliances.
Tightened credit has also created cash flow problems among iron ore traders, forcing some to sell stocks at a loss and putting iron ore prices under further downward pressure.
WEATHERING THE DECLINE?
Short sellers in the equities market have targeted Australia's Fortescue Metals Group for its exposure to iron ore. Australia's no. 3 producer and once a darling of the Australian share market, Fortescue stock has fallen 35 percent to date from its 2012 peak to close on Friday at A$4.
Still, the big miners have remained mostly bullish, insisting low production costs means they can weather a price decline more easily than higher-cost competitors.
"At current market prices, smaller high-cost iron ore producers will start to drop out of the market," said Jose Carlos Martins, Vale's ferrous metals director.
Ambitious expansion plans remain intact. Fortescue said it is on track to reach its 155 million-tonnes-per-year target rate by mid-2013 despite seeing its expansion costs balloon by $2 billion to $9 billion.
"Margins are still pretty healthy for the iron ore miners and it's not yet clear how China will turn out," said David Lennox, a mining analyst for Fat Prophets in Sydney.
Higher cost Chinese iron ore producers may struggle, said Peter Norfolk, research director with Freight Investor Services, a London-based derivatives consultancy. That alone might be enough to support prices, he added.
"Certainly, recent experience has been that around this level of $120 per tonne there has been some stabilisation of prices," he said. "Way back before in 2009 we have seen prices much lower than they are now and clearly we are going to need some demand-side stimulus for prices to head north again."
With traders and mills seeking to reduce their inventories, the removal of high-cost Chinese iron ore producers from the market might not have much of an impact.
"Reduced consumption of iron ore and high inventories mean that high-cost domestic miners may not offer much support for prices in the short term," said Halpin of MEPS.
SUPPLY AND DEMAND
While daily steel output has remained close to record levels since May, Chinese mills are unlikely to try to maintain those output levels over the slower summer months.
"In the past, steel mills have kept output high during the summer, in anticipation of an autumn recovery. This speculation-driven support for summer steel production is likely to be absent this year, however," said Halpin.
"Reduced purchases of iron ore reflect that. We would argue that this is not a pause in buying, as mills seek to drive iron ore prices lower, but an indication that mills are paring production plans for the summer period."
Daily output stood at 1.993 million tonnes in mid-July, up 1.8 percent compared to the first 10 days of the month, but there are already indications that mills have started to schedule "overhauls" and cut output over the slow summer months.
Medium-sized mills, together with the subsidiaries of giants like Baosteel, have already started cutting back output in order to prop up prices.
But analysts say the underlying problems won't be addressed until the Chinese government has found a way to kickstart demand.
"Clearly, outside China, demand is desperately poor and is set to be so for at least the rest of the year," Norfolk said.
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