(Reuters) - Indian manufacturing activity expanded at its fastest pace in two years in December as new orders flooded in and factories kept price increases to a minimum, a business survey showed on Friday.

Strong new business reinforces Finance Minister Arun Jaitley's view that the economy will grow "much better" in 2015/16, while weaker inflation gives the Reserve Bank of India (RBI) more room to cut interest rates as expected this year.

The HSBC Manufacturing Purchasing Managers' Index (PMI), compiled by Markit, rose to 54.5 in December from 53.3, its highest since end-2012 and its 14th straight month above the 50-mark that separates growth from contraction.

The survey also showed input prices slumped to a near six-year low as oil prices tumbled.

In November, India's annual consumer price inflation fell to 4.38 percent, well below the 8 percent which the RBI had hoped to achieve by the end of the year and the lowest since the government started releasing the data in 2012.

"With the disinflationary trend gaining ground, the RBI is expected to find space for some rate cuts in 2015," said Pranjul Bhandari, chief India economist at HSBC.

A Reuters poll predicted the RBI would start cutting its key lending rate from 8 percent in the second quarter.

But despite surging factory production, driven by improved business conditions and strong domestic and foreign demand, factories cut headcount at the steepest rate for nearly three years.

An employment sub-index slipped to 49.6 from November's 50.2.