* Main steel product inventories fall 2.8 pct from end-Oct
* Demand to improve in Q4, but oversupply to weigh on prices
* Financing costs for large mills up 29 pct for Jan-Sept on yr (Adds details, background)
By Ruby Lian and Fayen Wong
SHANGHAI, Nov 14 (Reuters) - A recent rally in steel prices in China, the world's top steel market, may lose steam as overcapacity continues to eat into steelmakers' margins, offsetting a recent drop in inventories, the China Iron & Steel Association (CISA) said on Wednesday.
Total inventories of five main steel products including hot-rolled coil and rebar in 26 major markets fell 2.8 percent from the end of October to 12.08 million tonnes on Nov. 9, CISA said in a statement on its website.
"Rising fixed asset investment in the fourth quarter will lift demand for steel," CISA said, referring to increased investment in railway and other infrastructure construction, but warned that cold weather in the northern regions and growing supplies will weigh on steel rebar prices.
Rebar prices have jumped as much as 16 percent from their lows in September due to a seasonal pickup in demand.
"The rise in steel prices have encouraged some suspended capacities to return," CISA said, adding that the oversupply situation has worsened in the southern provinces because sellers have moved their stocks from the north as icy weather has halted construction activities.
Apparent crude steel consumption in China rose only 0.65 percent to 510.3 million tonnes for the first nine months from a year earlier, compared with a 10.38 percent growth last year, CISA added.
China's average daily crude steel output has stayed above 1.9 million tonnes in the last two months, up from 1.89 million tonnes in August.
A jump in financing costs was also weighing on the country's large steelmakers, CISA said. The cost of borrowing rose 29 percent from year ago to 61.2 billion yuan in the January-September period.
"The steel sector is facing the capital tightness, and losses that a few steel mills made have already affected their normal operations," CISA added. (Editing by Himani Sarkar)