* Brent falls below $118 after China flash HSBC PMI
* Sentiment supported by euro zone, U.S. debt talk hopes
By Seng Li Peng
SINGAPORE, July 21 (Reuters) - Brent crude reversed early gains on Thursday to drop below $118 after news that China's factory sector contracted at its fastest pace in 28 months, but hopes of solutions to sovereign debt woes on either side of the Atlantic could keep a floor under prices.
Brent
The HSBC flash PMI, the earliest available indicator of industrial activity in China, the world's No 2 oil consumer, fell to 48.9 in July, its lowest since March 2009, as monetary policy tightening and slack global demand weighed on the economy. The index was last below 50 in July 2010.
The 50-point level in the PMI demarcates expansion from contraction, with a reading above 50 indicating growth.
"The knee-jerk reaction is to sell off assets like oil. Something is always going to take a bit of a hit, or a blow somewhere, and it looks like it is going to start in the manufacturing sector," said Ben Le Brun of CMC Markets in reference to the fall in PMI.
"This is not official data. It's from HSBC although the official rating will show contractions when released," he said.
"The fall is a cause of concern but it should not be completely unexpected. The Chinese government's attempt to cool the economy is starting to work."
But the mood is not all sour as temporary solutions to tackle debt problems in the euro zone and the United States could support prices in the short term, analysts said.
"We have the euro summit tonight and there's a good sentiment flying out of that between Germany and France," said le Brun. "If we get some good dialogue, then certainly oil traders will focus on that."
Germany and France have reached a common position on a second bailout of Greece in their bid to keep the country's debt crisis from spreading through Europe, officials said on Thursday, in news that set the euro rallying against the dollar.
In the United States, the White House signaled it could support a short-term increase in the U.S. borrowing limit for "a few days" if lawmakers agreed to a broad deficit reduction deal but needed more time to pass it.
The move, a shift from President Barack Obama's previous position, reflects the growing political reality that time is short for Congress to pass a massive deficit-cutting deal before the United States runs out of money on Aug. 2.
"Market sentiment has been on a roller coaster. There is still going to be a lot of nervousness about the ongoing situation in the U.S. and Europe, but the market is certainly a little more confident than a week ago," said economist David Cohen of Action Economics.
CRUDE STOCKS, JAPAN DATA SUPPORTS
"The Japanese trade numbers for June reported this morning offer some encouragement that the Japanese economy is rebounding nicely from the quake. In that context, commodity prices would be supported," said Cohen.
Japan's exports rose in June from the prior month and the pace of annual declines slowed, bringing the trade balance back into surplus as factory output and sales recover steadily from the March earthquake, tsunami and nuclear meltdown.
A drawdown in U.S. stocks and hopes that the International Energy Agency was unlikely to release more oil from reserves should also support prices.
U.S. crude stocks dropped 3.73 million barrels last week, more than twice the volumes analysts had expected in a Reuters poll. The drawdown came as refiners stepped up utilization to 90.3 percent of capacity, the most in almost a year.
Developed nations are unlikely to release more oil on to the market in coming days, a month after the first release failed to curb oil prices to help protect the global economic recovery, officials and analysts said. (Editing by Himani Sarkar)