* Dalian iron ore falls 3.1 pct, Shanghai rebar down 0.9 pct
* Decline in steel inventory shows strong demand - Morgan Stanley
By Manolo Serapio Jr
MANILA, May 23 (Reuters) - Iron ore futures in China fell more than 3 percent on Tuesday, retreating along with steel prices, after rallying in the prior session, although the outlook for demand in the world's top steel consumer remained bright.
Abundant supply of the steelmaking raw material also weighed on iron ore prices. Inventory of imported iron ore at China's ports reached 136 million tonnes last week, the most since 2004, according to SteelHome consultancy. SH-TOT-RBARINV
China is clamping down on polluting mills in Hebei, its top steelmaking province, curbing demand for iron ore, traders said.
The most-active iron ore on the Dalian Commodity Exchange closed down 3.1 percent at 479 yuan ($70) a tonne, after scaling a two-week high on Monday.
China's imports of iron ore have risen 9 percent to 353.09 million tonnes in the four months through April.
Iron ore for delivery to China's Qingdao port .IO62-CNO=MB rose 0.8 percent to $63.19 a tonne on Monday, its strongest since May 4, according to Metal Bulletin.
On the Shanghai Futures Exchange, construction steel product rebar dropped 0.9 percent to 3,295 yuan per tonne, having touched a nine-week peak in the previous session.
"I don't think the movements in futures reflect the fundamentals of the market," said a Shanghai-based trader.
"In the physical market, there are some expectations that steel demand will be firm after the summer, given declining inventories. We will also continue to see the impact on supply from China's environmental protection campaign."
Inventory of steel products held by Chinese traders dropped 5.6 percent from the previous week to May 19, according to data tracked by Morgan Stanley.
Steel stocks at China's mills have fallen 3.5 percent in the 10 days starting April 20, it said.
"In our view, the decline in inventory indicates strong downstream demand," the bank's analysts said in a report. ($1 = 6.8884 Chinese yuan) (Reporting by Manolo Serapio Jr.; Editing by Sherry Jacob-Phillips)