The central bank has already started to tap on the monetary brakes, notably by raising banks' required reserves, and economists expect further tightening steps in the months to come.

“Given the continued strength in real economic growth and the renewed expansion in credit supply, we believe it is important to stay highly vigilant on inflation,”Yu Song and Helen Qiao, economists with Goldman Sachs, said in a note to clients.

The consumer price index rose 1.5% in the year to January, slowing from a 1.9% increase in the year to December and undershooting forecasts of a 2.0% rise, data from the National Bureau of Statistics showed on Thursday.

China's economic data at the turn of the year are tough to read because of distortions caused by the variable timing of the week-long Lunar New Year holiday.

Winter weather can also play havoc with output and prices. Heavy snow, for instance, was largely to blame for a quickening of inflation in December as it pushed up the price of vegetables. Food makes up one-third of China's CPI basket.

“I think it is a temporary dip. I expect the February number to be much stronger, partly because the New Year holiday switched from being in January last year to February this year,”said Tao Wang, an economist with UBS in Beijing.

“But we expect the February number to be close to 3%, certainly above 2, so pressure for a rate hike in the second quarter is very strong,”she said.

LENDING CONTROLS

The determination of China's Communist Party planners to keep a grip on the economy was evident in loan figures for January.

Bank lending of 1.39 trillion yuan was the third-largest monthly total on record and surpassed forecasts of 1.35 trillion yuan. But, given that banks had already lent 1.1 trillion yuan by mid-January, the full-month total showed the success of subsequent arm-twisting to slow the pace of credit growth.

“The government, with its very early action on direct control of credit, has been able to keep overall lending below last year's level,”Wang said.

Banks lent a record 1.62 trillion yuan ($237.3 billion) in January 2009 as they heeded the party's call to pump up credit and revive an economy brought to its knees by the global financial crisis.

Banks went on to lend a total of 9.5 trillion yuan in 2009, providing the fuel for GDP to expand 8.7%, by far the strongest growth rate of any major economy. This year, Beijing has set a lower new-loans target of 7.5 trillion yuan.

“If they are able to keep things below last year, then we have confidence that they can achieve the 7.5 trillion for the year and we will be able to avoid a boom-bust cycle,”Wang added.

Year-on-year growth in the stock of outstanding loans fell to an 11-month low in January, a further illustration of how the central bank is gradually withdrawing the extraordinary monetary stimulus it injected into the economy last year.

INFLATIONARY RUMBLINGS

One unknown for policymakers is whether manufacturers and wholesalers will be able to pass on rising prices to consumers.

Factory-gate prices rose 4.3% in the year to January, accelerating from a 1.7% rise in the 12 months to December. Economists had expected a 4.2% increase.

There is no close link between the two inflation gauges in China, partly because of fierce competition and also because steady increases in productivity keep a lid on unit costs.

But some economists point to a combination of factors that could fuel consumer inflation.

Credit growth leapt 31.7% last year; minimum wages are rising in some coastal manufacturing provinces and some analysts suspect that a resumption of fast economic growth is reducing spare capacity.

One critical inflation threshold for the central bank is 2.25%, the maximum rate that banks are allowed to pay on one-year certificates of deposit.

If inflation exceeds that rate, people and companies will have an incentive to take their money out of the bank and invest in property and shares, which could inflate asset bubbles.

Goldman Sachs said this week that the inflation intolerance level for policymakers in Beijing was above 4%, while the China Business News identified 3% as the key level.

If inflation exceeds that level or if the Federal Reserve raises US interest rates, the People's Bank of China could respond by raising its own interest rates or further increasing the proportion of deposits that banks must hold in reserve at the central bank instead of lending out, the paper said on Thursday.

The PBOC raised required reserves by half a%age point last month, taking them to 16% for big banks and sparking a global markets sell-off on fears that China was slamming the brakes on an economy that has been a major force behind the global economic recovery.

Premier Wen Jiabao has said China will be paying more heed to month-on-month changes since year-on-year comparisons are distorted by the depressed state of the economy in early 2009.

In January alone, consumer prices rose 0.6%, following a 1.0% rise in December.

“I don't think the central bank will introduce blanket aggressive tightening measures in the first half, especially since CPI was not as high as the market expected. So we still need to wait and see more monthly figures to judge the monetary policy shift,”said Nie Wen, an economist at Fortune Trust Co in Shanghai. (Reuters)