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China's Wen says inflation top priority, more tightening seen

By Kevin Yao and Yan Jiang

SHANGHAI/BEIJING (Reuters) - China's premier and the country's central bank governor vowed on Monday to prevent stubbornly high inflation from upending the economy, reinforcing expectations for more increases in interest rates and bank reserve requirements.

Premier Wen Jiabao said tackling inflation was the government's top policy priority while central bank governor Zhou Xiaochuan said the authority needed to make maintaining price stability "more prominent and important."

Inflation rose to a three-year high of 6.4 percent in June, data showed on Saturday. The comments mark a fresh attempt to show the inflation fight is far from over and the government is determined to bring prices back under control, analysts said.

"If they signal any comfort with inflation, and inflation is as high as it is now, they could create an environment in which people would panic, and they can have a real problem on their hands," said Tim Condon, head of Asia research at ING in Singapore.

Wen declared curbing price pressures as the top priority in China's version of a "State of the Union" address in March, when inflation was 1 percentage point lower than June's level.

The Communist Party is worried that rising prices could spill over into public protest. Wen said in March that inflation could threaten social stability in the world's second-biggest economy.

"We must treat stabilizing overall price levels as the top priority of our macro-economic controls and keep the direction of macro-economic adjustments unchanged," Wen said in remarks reported on Monday by the central government's Internet portal. (www.gov.cn)

He said the government would try to stabilize prices of pork, a staple meat for Chinese and the most closely watched item in controlling inflation, by boosting the supply of hogs. Pork prices in June shot up 65 percent from a year earlier, official figures show.

China would maintain a "prudent policy" to bring prices back under control while trying to avoid causing big swings in economic growth, Zhou said.

"The most prominent problem in macro-economic operations is the relatively big inflationary pressure and still strong inflationary expectations," Zhou wrote in the latest edition of China Finance magazine, published by the People's Bank of China.

"We must make it more prominent and important to maintain basic stability of the overall price level, and pay attention to price stability in a wider scope," Zhou said.

China's inflation has largely been driven by rising food costs, which rose 14.4 percent in the year through June.

June's headline inflation was slightly above the 6.3 percent forecast in a Reuters poll and revived expectations of more interest rate rises in the next few months.

The data, combined with weak jobs growth in the United States and lower than expected imports in China in June, rattled Asian stock and commodities markets.

GROWING DOWNSIDE RISKS?

Zhou also said that the central bank would work to "avoid big fluctuations" in the economic growth, indicating some concerns over risks to the economy.

"We should implement prudent monetary policy in a pro-active and safe way to handle the relationship between maintaining stable, relatively fast growth, adjusting economic structures and managing inflationary expectations," he said.

China's import growth fell to its slowest pace in 20 months in June while export growth eased, signs that tighter monetary conditions and sluggishness in global demand were dragging on the economy.

The central bank has raised interest rates five times and bank reserve requirements nine times since last October as the inflation threat has grown.

It has also issued a flurry of measures aimed at rising property prices to prevent a real estate bubble from forming.

Xia Bin, a central bank adviser, told the China Securities Journal that Beijing needed to use a mix of policy tools to battle inflation, including interest rates, the currency, open market operations and changes in bank reserve requirements.

MARKET-ORIENTED TOOLS

Many analysts expect the central bank to lean more on interest rates to fight inflation in coming months, partly because they see limited room for higher bank reserve ratios, which for big banks stand at a record 21.5 percent.

Inflation pressures are also spreading, providing another reason why the broader impact of interest rates may be a more effective tool. Inflation less food was 3.0 percent in June, the highest since records began in 2002.

"Monetary policy should make a gradual departure from the path of quantitative tightening and move toward relying primarily on adjusting interest rates," Liu Yihui, a researcher with the Chinese Academy of Social Sciences -- a top government think tank, told the official China Securities Journal.

A Reuters poll last week shortly after the latest rate rise from the central bank showed a small majority of analysts expected at least one more rate rise this year.

Chi Sun, China economist at Nomura in Hong Kong, predicted four rate rises in 2012 as rising wages fuel inflation.

Governor Zhou was not specific about how the central bank would tackle inflation in the months ahead.

"We will use more market-oriented tools and means to maintain necessary controls on liquidity, while maintaining a reasonable amount of social financing to avoid big fluctuations in economic growth," he said.

Market-oriented tools typically include interest rates, exchange rates and bank reserve requirements, Gao Shanwen, chief economist at China Essence Securities in Beijing said.

($1=6.465 yuan)

(Additional reporting by Zhou Xin, Lu Jianxin and Carrie Ho; Editing by Ken Wills and Neil Fullick)

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