By Aileen Wang and Kevin Yao
BEIJING (Reuters) - China's annual consumer inflation slowed more sharply than expected to a seven-month low of 2.5 percent in December, easing market fears of monetary policy tightening although the central bank is tapping the brakes on bank liquidity.
Rising money market rates and bond yields indicate the People's Bank of China (PBOC) is targeting bank liquidity conditions to reduce debt levels and contain credit growth, but there is little sign of a sharp turnaround in its policy stance.
The central bank has pledged to continue to maintain prudent monetary policy in 2014 and keep reasonable money and credit growth to support the real economy.
"Inflation pressures remain modest, which will allow policymakers to continue focusing on policies to support growth while implementing structural reform measures in 2014," said Xiaoping Ma, an economist at HSBC in Beijing.
The drop in inflation last month, from November's print of 3 percent, was sharper than a fall to the 2.7 percent rate expected by the market, slowed by volatile food costs.
PRICE PRESSURES TO PICK UP IN 2014
Food prices rose 4.1 percent in December from a year earlier, slowing from November's 5.9 percent rise, the National Bureau of Statistics said on Thursday.
Month-on-month, consumer prices rose 0.3 percent versus 0.4 percent expected by economists.
But analysts warn inflation may quicken in coming months as the government pushes market-oriented reforms to liberalize energy and utility prices.
"While CPI inflation came in lower than expected, the January figure will likely exceed 3 percent again due to the Chinese New Year effect," said Zhou Hao, an economist at ANZ in Shanghai.
"Inflation could exceed 3.5 percent in the second half of 2014, as upcoming pricing reforms could push up commodity and public utility prices. Therefore, we think that CPI inflation will be 3.2-3.4 percent on average this year."
China's inflation was 2.6 percent over the whole of 2013, well within the government's target limit of 3.5 percent, the bureau said. Analysts believe the government will also stick with the 3.5 percent inflation target this year.
The bureau also said that China's producer prices fell 1.4 percent last month from a year earlier - the 22nd consecutive month of decline - versus the same rate of factory price deflation in November.
Analysts expect the Chinese authorities to rein in the sprawling shadow banking sector under their long-term deleveraging drive in a bid to put the world's second-largest economy on a more sustainable footing.
Reuters reported earlier this week that the State Council, China's cabinet, had issued new policies to strengthen regulation of off-balance-sheet lending in an effort to contain the risk of a debt crisis.
"Inflation is not a major concern at this stage, but the crackdown on shadow banking will likely intensify, and financial institutions may need to deleverage further," Zhiwei Zhang, China economist at Nomura in Hong Kong, said in a research note.
The inflation news precedes December trade figures due on Friday and fourth-quarter gross domestic product data due on Jan 20.
Economists polled by Reuters forecast annual economic growth could slow to 7.6 percent in the fourth quarter from 7.8 percent in the previous quarter, putting 2013 GDP expansion on track for the weakest showing in 14 years.
Chinese leaders have pledged reasonable growth in 2014, and sources at top government think tanks told Reuters they expect a growth target of 7.5 percent, the same as for 2013.
(Editing by Eric Meijer & Kim Coghill)