* Euro zone inflation drops to 26-month low of 1.6 pct y/y
* Toyota to suspend production in Japan for 11 days
* Euro zone services survey hits lowest in 10-year history
* China risks protest, riots as unemployment rises - report (For more on the crisis, click)
By Will Waterman
LONDON, Jan 6 (Reuters) - Dire economic data underlined the severity of recession in Europe on Tuesday, while Toyota Motor Corp said it would halt all production in Japan in response to plunging demand.
With the global downturn hitting automakers particularly hard, Toyota, the world's biggest, said it would shut all its factories in Japan for 11 days over February and March.
And as a further indication of how the crisis that began with bad housing loans in the U.S. has reached all parts of the world, a state-run Chinese magazine warned that rising social unrest would follow.
In Europe a sharper than expected fall in euro zone inflation to a 26-month low of 1.6 percent in December knocked back the euro and further supported expectations for a European Central Bank (ECB) rate cut next week.
ECB rate cut expectations were also boosted by data showing the euro zone private sector services economy shrank sharply in December and firms cut more jobs than expected, pointing to a deep recession lasting for a good part of 2009.
The Markit Eurozone Purchasing Managers' Index of about 2,000 services companies, from banks to retailers, fell to 42.1 in December from 42.5 a month ago, a new low in the survey's 10-year history.
"Sharply contracting new orders, backlogs of work and employment reinforce belief that the euro zone faces an extremely difficult start to 2009," said Howard Archer, economist at IHS Global Insight.
The euro plunged against the dollar to $1.3347 from $1.3440 in response to the data.
A services sector survey for the UK also showed an eighth month of contraction, with the employment component dropping to a record low, while UK retailers warned that rising job losses and plunging house prices would blight trading for months..
Adding to Europe's economic woes, a gas pricing dispute between Moscow and Kiev threatened supplies to the continent as Russian gas via Ukraine to southeast Europe and Turkey was halted, pushing U.S. crude oil prices up $1.50 to $50.33 a barrel, and British gas market prices up more than 10 percent.
Flows were cut to Bulgaria, Turkey, Macedonia, Greece and Croatia, while Italy, Austria and the Czech Republic reported sharp falls. European energy firms receive about a fifth of their gas via pipelines through Ukraine.
STIMULUS PLANS
But European and Asian shares rose for their sixth and seventh straight sessions respectively, and the dollar climbed as investors anticipated an economic stimulus package of up to 50 billion euros ($67.4 billion) in Germany and an expected $775 billion bill from U.S. President-elect Barack Obama.
The South Korean government also said on Tuesday it aimed to create almost 142,000 jobs this year through infrastructure and environmental projects, part of a five-year, $38 billion plan to generate almost 1 million jobs.
"Growing expectations for the administration of Obama are making investors that much more willing to take risks, and I think we're also seeing more buying by foreign investors," said Hideyuki Ishiguro, supervisor at the investment advisory department of Okasan Securities in Tokyo.
MSCI's All-Country World stock index has jumped 25 percent since a five-year low in late November.
POOR DATA
Market optimism is running ahead of economic indicators, however, which remain poor.
Britain's Nationwide Building Society said house prices in the world's fifth-biggest economy fell another 2.5 percent in December, making 2008 the worst year on record.
Consumer morale slumped in December in both Britain and France on fears of rising unemployment, which along with tight credit have particularly hit car sales across the globe.
Figures on Monday showed that auto sales in the U.S. fell 36 percent in December, closing out the weakest year since 1992 in the world's biggest market, where Toyota saw its worst monthly sales decline since at least 1980.
The company, having already announced a three-day suspension at domestic plants this month and warned of its first-ever annual operating loss, said it would halt output at 12 vehicle and parts plants in Japan for six days next month and five in March.
In China, which relies on strong growth to create jobs for its millions of migrant workers and graduates, state-run Outlook (Liaowang) Magazine said on Tuesday that rising unemployment in 2009 threatened an upsurge in protests and riots.
"Without doubt, now we're entering a peak period for mass incidents," Huang Ho, a reporter from state news agency Xinhua, told the magazine.
Though researchers at the country's central bank forecast China's economy would grow 8 percent this year, many independent analysts' predictions are substantially lower. (Additional reporting by Reuters bureaux worldwide; Editing by Richard Hubbard)