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Prior to installation, the installer checks the available disk space. This is, however, done before the dialog for choosing the target partition is shown and only for the system partition, as it seems. The only partition with enough free space at that time was my USB drive, by the way. The result is, that if one doesn't have enough free disk space on the system partition, the installation fails, before the user is allowed to choose a different partition.
In reality, installer need some extra space not at the system partition, but at the user home directory (in case of Windows - it is the same). Yes, we need some space at %USERPROFILE% directory to extract installation data before real installation. In fact, that data is deleted after installation.
*** Issue 156354 has been marked as a duplicate of this issue. ***
*** Bug 179652 has been marked as a duplicate of this bug. ***
Assigned to new owner.