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China's economy cools, limiting need for tighter policy

By Kevin Yao and Aileen Wang

BEIJING (Reuters) - China's industrial output growth eased much more than expected in April to suggest the world's second-biggest economy is cooling, reducing the need for further aggressive monetary policy tightening even as inflation remains stubbornly high.

Consumer inflation eased modestly to 5.3 percent in April from a 32-month high in March of 5.4 percent. The outcome topped expectations but still underlined the view that price pressures are peaking and may start to ease in the second half of 2011.

Industrial output rose 13.4 percent from a year earlier, but that was more than a full percentage point below both expectations and a strong pace in March.

Retail sales growth eased more than expected while annual increases in money supply and outstanding yuan loans hit their lowest pace in 29 months, signs that measures to slow the economy are starting to bite.

Most analysts said the central bank could now reduce the scope of further tightening in monetary policy, while a prominent Chinese government economist went further, saying policymakers may be concerned about an overly rapid slowdown.

"The central bank will be very cautious about raising interest rates," said Wang Jian, a researcher with the National Development and Reform Commission. "In fact, I believe it may stop raising interest rates but cut interest rates in the second half of the year," he told Reuters in an interview.

Other analysts were not so sure. The central bank is approaching the end of a monetary tightening cycle after four rates rises since October, and seven increases in bank reserve requirements to a record 20.5 percent for big banks, they said.

But some more tightening would be needed, they said.

"The April economic indicators make it less likely that the central bank will raise required reserve ratios or interest rates. I believe the central bank will, at most, raise reserve requirements once in the coming two months," said Shao Yu, an economist with Hongyuan Securities in Shanghai.

The world's fastest-growing economy expanded more than 10 percent last year as it emerged strongly from the global financial crisis.

Policymakers, targeting 4 percent average inflation this year, have declared tackling inflation their top priority for this year after high food prices raised fears of broader inflation that could derail the recovery or even spark social unrest.

Food prices fell 0.4 percent in April from March but were 11.5 percent higher than a year earlier. Non-food prices rose 0.4 percent in April from March.

Analysts have said that falling food prices point to an easing of overall inflationary pressures. Overall inflation may still rise through mid-year -- partly to reflect a low comparative base in 2010 -- but it would ease in the second half of the year.

"The data suggests that previous measures to get a grip on lending and growth have had an impact," said George Worthington, chief Asia economist, IFR Markets, a unit of Thomson Reuters, in Sydney.

TIGHTENING BITES

Figures from the National Bureau of Statistics showed that output growth in all major industries slowed down in the year through April.

Growth in output of most major products also slowed down, including cement, although the pace of crude and cast iron production picked up.

Analysts said industrial output was partly reined in by supply constraints in electricity, but still showed the economy was cooling.

The slowdown "reflects progressing weakness in final demand as tightening measures start to bite," IHS Global Insight said in Beijing.

"A hard-landing scenario is still a low probability, though," economists Xianfang Ren and Alistair Thornton said in a note.

Retail sales rose 17.1 percent, lower than 17.6 percent forecast in a Reuters poll and weakening from 17.4 percent in March.

Chinese banks extended 739.6 billion yuan ($113.9 billion) in new yuan loans in April, more than market forecasts for 700 billion yuan, People's Bank of China figures showed.

M2 money supply growth of 15.3 percent was lower than forecasts of 16.5 percent and was the lowest pace in 29 months.

Outstanding yuan loans at the end of April were 17.5 percent higher than a year earlier, also the weakest pace in 29 months, adding to expectations that inflation, which usually lags money supply trends, may moderate.

"The economy is slowing, but not very seriously. It is still far from the warning line for the Chinese leadership. There is no room for the central bank to relax its monetary tightening," said Chen Gang, economist with CEBM in Shanghai.

But the possibility the central bank might resume issuance of 3-year bills, on top of other short term bills it issues, suggested it might opt for open market operations rather than outright rate rises or higher reserve requirements to manage monetary conditions, analysts said.

NO LET-UP YET

Though far too soon for Beijing to declare victory in its battle against inflation, the stabilization of prices suggested that tighter policy was beginning to produce initial results.

"We should say that the upward price trend has been curbed initially and the government measures to control price rises have produced initial effects," Sheng Laiyun, the spokesman of the National Bureau of Statistics, told reporters.

"But we are still facing relatively big inflation pressure. On the one hand, we are facing the big imported inflation pressure, and on the other hand, from the domestic market, we are facing rising labor costs.

"Therefore, we must not underestimate the situation and keep making it the priority to control price rises."

Still, some analysts said it could be tough for China to achieve its 4 percent inflation target this year given increasing labor costs and rising commodity and fuel prices.

Chinese policymakers have made it clear they will deploy the currency as a weapon to deal with the inflationary impact of rising commodity prices, although they also worry that faster yuan rises could hurt exporters and fuel hot money inflows.

U.S. Treasury Secretary Timothy Geithner has pressed China in talks in Washington this week to allow a faster rise in the yuan, which it argues is kept on a tight leash by Beijing to boost exports.

The yuan has gained about 5 percent against the dollar since it was depegged from the dollar in June 2010 and nearly 1.5 percent since the start of this year.

Sheng highlighted Beijing's dilemma on the currency.

"Theoretically, the appreciation of one currency may help ease imported inflation pressure. But currency appreciation is a double-edged sword, which should be used depending on different conditions," he said.

(Additional reporting by Zhou Xin, Langi Chiang; Writing by Neil Fullick; Editing by Ken Wills and Vidya Ranganathan)

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