REFILE-WRAPUP 1-China prices fall, market looks past deflation

* Consumer price fall eases in May

* Producer price drop accelerates, but deflation unlikely

* Newspapers report May Industrial output up 8.9 pct y/y (Refiles to drop erroneous word in paragraph 3)

By Langi Chiang and Simon Rabinovitch

BEIJING, June 10 (Reuters) - Chinese consumer prices fell in the year to May for the fourth month in a row, but at a slightly more moderate pace, reassuring economists who play down the risk that deflation could take root.

Producer prices fell more steeply in May, marking the biggest decline in at least a decade, though this was mainly because of a high base of comparison after a commodity price surge last year, also giving analysts little cause for concern.

In any event, niggling worries about deflation could be swept aside later in the week if media reports of upside surprises in China's factory output, investment and bank lending figures are confirmed.

The most striking of the numbers carried by two separate Chinese newspapers was an 8.9 percent rise in industrial production in May from a year earlier, well ahead of forecasts and the fastest growth since September last year. The same newspapers had accurately reported the inflation data ahead of the official release. [ID:nPEK63329]

For now, though, inflation is the only May data known with certainty.

Consumer prices fell 1.4 percent in the year to May, the National Bureau of Statistics said on Wednesday. Economists had expected a 1.3 percent decline in the consumer price index (CPI) following a 1.5 percent fall in the year to April.

Analysts said that on a seasonally adjusted month-on-month basis, consumer price inflation has been positive for three consecutive months.

China's producer prices, meanwhile, fell 7.2 percent in the year to May, the biggest decline since records began in December 1998 and accelerating from a 6.6 percent drop in April. Economists polled by Reuters had expected the producer price index (PPI) to fall 6.8 percent.

"Inflation, rather than deflation, is the key concern," said Zhou Xi, an economist with Bohai Securities in Tianjin. "China's consumer price index will definitely move into positive territory later this year, and the PPI may move into positive range a little bit later."

The Shanghai stock market .SSEC closed 1.02 percent higher versus a rise of 0.37 percent prior to the data.

It was also lifted on reports that fixed-asset investment would top expectations in May, making for 32.9 percent annual growth in the year to date.

China did report on Wednesday that annual growth in real estate investment rose 6.8 percent in the first five months, up from 4.8 percent in the January-April period, suggesting a big pick-up in capital spending in the property sector in May. [ID:nPEK185473]

Optimism about the Chinese economic data to come over the rest of this week helped fuel a 2.1 percent rise in Japan's Nikkei stock average to an eight-month closing high and drove Hong Kong shares up 3.3 percent. It also lifted metals and oil prices to or near multi-month highs. [ID:nSP432203]

ON THE REBOUND

With deflation likely to be short-lived, authorities would not take the declining prices as an impetus to cut interest rates further, Jun Ma, an economist at Deutsche Bank in Hong Kong said.

"I don't think they'll be easing any more. They look not only at the prices but also at what happens in lending, which is more important than any other indicators," he said. "Lending has been excessive over the past four to five months."

Chinese banks extended 664.5 billion yuan in new loans in May, topping most forecasts, according to separate reports on Wednesday in China's 21st Century Business Herald and Hong Kong's Ming Pao.

To complement the Chinese government's 4 trillion yuan economic stimulus package, banks had already lent a record 5.17 trillion yuan in local-currency loans in the first four months of 2009 -- more than Beijing's minimum target of 5 trillion yuan for the whole of the year.

As evidence accumulates that the government's push is working -- and quickly -- some analysts have begun to point to the prospect of a rising inflation as a more pressing worry.

Goldman Sachs economists Yu Song and Helen Qiao cast doubt on this, though, saying that there was still ample slack in the economy to accommodate a strong revival in business activity.

"High inflation should not be an imminent concern because of the significant negative output gap caused by the dramatic slowdown in the second half of 2008," they wrote in a note to client.

Producer prices tend to be more volatile than consumer prices in China, swinging higher on the ups and dipping lower on the downs. The transmission belt between the two is also quite weak, with PPI heavily influenced by global natural resource prices, while domestically determined food prices constitute about one-third of the CPI index.

For a graphic on Chinese CPI and PPI trends, click here (Additional reporting by Jason Subler and Zhou Xin; Editing by Ken Wills & Kazunori Takada)