China central bank says inflation fight a policy priority

A worker walks past a residential construction site in Beijing June 23, 2011.

BEIJING (Reuters) - China pledged to keep to a "prudent" monetary policy for the rest of the year to combat inflation, which is stubbornly fixed near a three-year high.

In the latest sign that Beijing is taking a gentle easing in China's economy well in stride, the central bank reiterated that fighting inflation remains its policy priority.

"Domestic inflation expectations remain on the high side," the People's Bank of China said in comments published on its website.

"The foundation work for stabilizing prices is not solid, and there is a chance of prices rebounding once policy is relaxed."

The hawkish remarks, released after a regular meeting of the heads of the central bank's branch offices across China, affirmed market expectations for Beijing to raise interest rates once more this year to quell inflation.

The comments offered few clues, however, on when the central bank would make its next move.

"Stabilizing prices will remain a policy priority," the central bank said. "We will continue to implement prudent monetary policy and keep the needed intensity in policies."

"We will use interest rates, foreign exchange rates, open market operations, reserve requirements and a mix of policy tools to maintain a reasonable rhythm and scale in total financing."

Since October, Beijing has raised interest rates five times and banks' required reserve ratio nine times to prevent rising prices from fuelling social unrest.

But even with the steady tightening, China's consumer price index hit a three-year peak of 6.4 percent in June as a spike in pork prices kept inflation elevated.

But with the Chinese economy easing slightly, many analysts think Beijing may delay its next policy move in a nod to softer growth, even though it is still firmly in tightening mode.

Such talk was reignited on Monday after a pair of manufacturing surveys showed Chinese factories struggling with their weakest activities in 28 months in July as tight policy at home and weak demand abroad hurt production.

The central bank did not address such speculation, and kept the thrust of its statement on the need to keep China's economy and financial system growing in a stable manner.

Below are a list of policy reforms or plans that the central bank promised to undertake:

-- Press ahead with liberalizing the interest rate market

-- Expand a nationwide yuan trade settlement scheme

-- Allow domestic firms to raise capital in yuan to support their overseas projects on a pilot basis

-- Allow foreign firms to make direct investment in yuan

-- Answer the government's call to not relax policy tightening in the property market

-- To further implement a policy of differentiated mortgage rates

-- To urge financial institutions to extend loans to eligible affordable housing projects

-- To reform the yuan exchange rate in a long-standing pledge

"We will further improve the yuan exchange rate mechanism and let market forces, as well as a basket of currencies, play a bigger role in deciding the yuan's value," the central bank said.

Despite years of promising to free up its currency regime, Beijing retains tight control over the yuan by deciding the yuan's daily value.

Also, many analysts think the yuan remains in a crawling peg to the dollar even though Beijing says the yuan's value is derived from a basket of currencies.

(Reporting by Aileen Wang and Koh Gui Qing; Editing by Jacqueline Wong)