Weak demand pressures Russian growth story

* Retail, investment data below expectations

* Data complicates monetary policy dilemma

* Political strains mount as economy slows

By Lidia Kelly

MOSCOW, Aug 20 (Reuters) - Russian consumers and companies are spending less freely than expected, data showed on Monday, pointing to easing economic growth and adding to the central bank's dilemma as it seeks to contain inflation in the face of a slowing economy.

Retail sales, a proxy for private consumption, grew by 5.1 percent in July, their weakest pace in more than a year and half and below analysts' expectations of a 6.4 percent rise, affected by rising prices that trimmed real disposable incomes.

Capital investment was also weaker than expected, increasing by 3.8 percent, against a forecast 5.3 percent rise and pointing to weaker corporate profits as demand in the euro zone - Russia's main export market - slows.

The disappointing batch of data could complicate monetary policy. The central bank at a policy meeting this month sent a strong signal that monetary tightening may be in store as it seeks to limit inflation to 6 percent this year, but it may now need to pay closer attention to a slowing economy.

The data "may somewhat cool the central bank's hawkish stance," Dmitry Polevoy, an economist with ING in Moscow, wrote in a note.

Russia's economy, which is benefiting from a strong price of oil, its chief export, grew by 4.4 percent in the first half of the year but is expected to slow in the second half due to weak global demand for other exports. The government forecasts full-year growth of 3.5 percent.

POLITICALLY CHARGED GOALS

The central bank, however, is unlikely to deviate too far from fighting inflation, which is currently running at 5.7 percent, and is likely to rise above 6 percent next month as dry weather hits this year's Russian grain crop.

Russia has been plagued by double-digit inflation for most of the past decade and hitting the inflation target would mark a milestone in the central bank's gradual shift to a full-blown inflation-targeting regime and away from its traditional focus on managing the exchange rate.

It would also help President Vladimir Putin, whose popularity has slipped since his return to the Kremlin in the spring, following a winter of opposition protests over alleged election fraud. The next protest is planned for Sept. 15.

The jailing last week of three members of the Pussy Riot punk group for two years in a high profile case concerning freedom of speech, could add to political strains, say analysts.

"Looking from the federal point of view and the political events that have taken place since the parliamentary election (Dec. 4), the (inflation) target's importance has increased," said Vladimir Pantyushin, chief economist at Barclays Capital in Moscow.

The weaker investment number will make it harder for Putin to hit his mid-term goal of raising investment to 25 percent of GDP by 2015, from around 20 percent last year, which is less than half the rate in faster-growing emerging peer China.

INFLATION FOCUS TO WIN OUT

Julia Tsepliaeva, head of Russia's market economics at BNP Paribas, does not expect the July economic data to affect the central bank's stance.

"Making its rate decision in August, the central bank has stressed that the bank was satisfied with the economic growth trend," Tsepliaeva wrote in a note.

"We do not expect July's macro indicators to change this view. Inflation (in particular imported food inflation) will remain in the main focus of the central bank and the government in the coming months."

Other analysts said the July macro data adds to uncertainty over the course of monetary policy in the autumn. They expect the focus on inflation will prevail though - with the central bank likely to tighten monetary policy if inflation pushes persistently above its 6 percent target. (Reporting by Lidia Kelly; Editing by Douglas Busvine and Susan Fenton)