UPDATE 1-Don't expect big yuan moves -PBOC adviser

* China c.bank adviser says yuan can rise or fall, gradually

* More flexible yuan leaves space for monetary policy tools

* Expectations of rising inflation persist, need attention

(Adds quotes, changes)

By Aileen Wang and Alan Wheatley

BEIJING, July 29 (Reuters) - The yuan CNY=CFXS can rise or fall under China's managed floating exchange rate regime, but only incrementally, Zhou Qiren, an adviser to the central bank's monetary policy committee, said on Thursday.

China dropped a 23-month-old peg to the dollar on June 19 and said it would henceforth steer the yuan, also known as the renminbi (RMB), with reference to a basket of currencies. The yuan has since gained 0.75 percent against the dollar.

"Under the current yuan exchange rate regime, the RMB can both rise or fall, but only in small steps, because Chinese exporters cannot accept big adjustments. It takes time," Zhou told Reuters.

He was speaking on the sidelines of a summer school at Peking University, where he heads the China Centre for Economic Research.

The more flexible exchange rate regime would give the People's Bank of China greater autonomy in the conduct of monetary policy and so enable it to make more use of various operational tools over the rest of 2010, he added.

The PBOC's monetary policy committee frames advice for the State Council, China's cabinet, which has the final say on important issues. The panel has three academic members.

Zhou sounded a note of caution about price pressures, even though consumer price inflation dropped to 2.9 percent in the year to June from 3.1 percent in the year to May.

"Inflation expectations are still there because we extended a record amount of loans last year. Excess liquidity will not disappear of its own accord," Zhou said.

Chinese banks lent 9.5 trillion yuan, or about 30 percent of GDP, last year at the behest of the government to help the economy ride out the global downturn.

Zhou gave short shrift to an International Monetary Fund assessment, in an annual health-check of Chinese policy released this week, that the yuan is undervalued.

"I don't believe in the report. To me, it's nonsense," he said, arguing that it was inherently impossible to define an equilibrium exchange rate. (Reporting by Aileen Wang and Alan Wheatley; Editing by Ruth Pitchford)