* Third consecutive monthly increase in inventory forecast
* Most of drop in Chinese demand offset elsewhere - USDA
* U.S. output estimate raised on Mississippi Delta crops
Oct 11 (Reuters) - The U.S. Department of Agriculture has raised its 2012/13 global ending stock forecast for cotton to record highs for a third consecutive month, sending prices down and reinforcing concerns about weakening demand from China, the world's largest textile market.
The government raised its inventory forecast for the season to end-July 2013 by 3.4 percent to a record of 79.11 million 480-lb bales due to a combination of sharply higher production and reduced consumption.
It was its third monthly increase since the new marketing season started on Aug. 1 and the highest since records began in 1960. The new total would also represent a 14-percent jump from 2011/12's 69.56 million bales.
Market participants were alarmed that the USDA cut its consumption rate for China by 2 million bales to 36 million, citing falling demand from mills, which have bought less due to high domestic prices.
"The high domestic support price continues to erode offtake," the report said.
It also raised its output forecast for the world's top three producers, China, India, the United States, as well as other major growers Brazil and Pakistan, taking the total up 2 percent to 116.32 million bales.
"It's a bearish rollercoaster," said Keith Flury, senior commodities analyst at Rabobank, pointing to falling consumption estimates for China, the world's largest user.
The benchmark December cotton futures in New York were down 1.5 percent at 71.02 cents per lb by 11:59 a.m. EDT (1559 GMT), on track for their largest one-day fall in two weeks.
Prices fell as low as 70.41 cents immediately after the publication of the USDA report, but recovered some lost ground after hitting near-term technical supports. Before the report's release, prices were down 1.08 percent at 71.32 cents.
While the report was bearish overall, prices were cushioned by a rallying grains market, said Sharon Johnson, a cotton specialist at Knight Futures in Atlanta, Georgia.
"(Grains) prices are moving higher and may provide some indirect support for cotton. At the very least, I look for a test of the 70.22 (cent) recent low basis December," she said.
A close below 70.65 cents per lb, the lowest in the past two weeks hit on Sept. 28, would signal additional downside pressure, she said.
Comments about an uptick in demand for raw cotton from other Asian countries provided some relief for traders and growers who fear that Chinese mills will cut their buying even further.
The report said the majority of the drop in Chinese demand was offset by an increase from other major spinning countries, including India, Turkey, Pakistan, Indonesia, Taiwan and Vietnam.
Those countries have access to cheaper raw cotton than their Chinese counterparts and have as a result increased their buying, it said.
Beijing has set local prices at around $1.40 per lb, almost double exchange prices, in an attempt to support the country's millions of farmers, traders have said.
While helping the agricultural industry, the strategy has hurt mills, whose margins have been squeezed, forcing them to import raw fibers when quotas are available. Those are limited in supply though and incur a hefty import duty if the finished product is not re-exported.
As a result, integrated mills buy more yarn, a semi-finished fiber, to process into finished product. That is more cost effective than buying and processing raw fibers, traders said.
That displacement of demand to other parts of the world should help alleviate concerns in the global cotton market about falling consumption, although some question how long Beijing will allow its mills to follow that strategy.
RISING U.S. OUTPUT
In its U.S. assessment, the USDA raised its output forecast by 1 percent to 17.29 million 480-lb bales even after the recent wet weather in west Texas, the country's main growing region.
That is up from an estimated 15.57 million in 2011/12 and is driven by increases in the Mississippi Delta states.
Heavy rain can damage quality and quantity of crops because most bolls, which are the protective capsule surrounding the fiber, are open this far into the season.
Exports were cut by 200,000 to 11.6 million bales due to slowing buying from China, while ending stocks rose by 300,000 to 5.6 million bales.
(Reporting by Josephine Mason in London; Editing by Dale Hudson, John Wallace and Bob Burgdorfer)
((Josephine.Mason@thomsonreuters.com)(+1 646 223 8925))
Keywords: COTTON USDA/CROP