* May home prices ease from April, first fall in two years
* Prices still up 5.6 pct on year but slowest gain in 13 months
* Spreading price weakness adds to other signs of cooling in property
* No signs of price collapse now but growing risk to economy (Adds comments)
By Xiaoyi Shao and Koh Gui Qing
BEIJING, June 18 China's average home prices fell for the first time in two years in May and price weakness spread to more major cities, adding to signs of cooling in the property market which are posing a growing risk to the broader economy.
The 0.2 percent monthly price drop in May, though slight, follows data last week that showed growth in property investment slowed while property sales and new construction tumbled, compounding the challenges for leaders in Beijing as they deal with an economic growth slowdown.
The real estate sector, which accounts for more than 15 percent of China's economic output and directly impacts around 40 other business sectors, could determine the severity of that downturn.
"If the cooling-off in real estate continues, the authorities will need to make more effort to manage the slowdown in the broad economy," said Lv Fengyong, a researcher at the Chinese Academy of Social Sciences (CASS), a government think-tank in Beijing.
Analysts said large inventories of unsold homes and recent sluggish sales are likely to trigger wider and deeper price cuts in coming months, as developers act to maintain cash flow. However, they said evidence of a sharp correction in home prices remains thin, putting to rest for now at least fears of a hard landing in the wider economy.
"The high inventories in some cities and developers' recent promotions, together with unclear market expectations that kept buyers staying on the sidelines, led the prices to fall," Liu Jianwei, a senior statistician at the National Bureau of Statistics (NBS), said in a statement accompanying the data on Wednesday.
New home prices fell in May from April in 35 of the 70 cities polled, up from eight cities in April. (For table with more price data, see )
Versus a year ago, new home prices rose 5.6 percent in May, easing from the previous month's 6.7 percent rise and the slowest annual rise in 13 months.
The worst year-on-year performance was in the eastern city of Wenzhou, where prices fell 4.4 percent in May.
A recent private survey showing China's vacancy rates were around 22 percent suggest a considerable overhang of inventory, which could undermine property as an investment class and add momentum to price declines. With its stock markets in a prolonged slump, property has been one of the few investments in China to offer attractive returns.
Moody's Investors Service last month cut its outlook for China's property industry to negative from stable, noting expectations of a slowdown in sales growth and a large supply overhang in the market.
"The risk of a more persistent and sharper downturn in the property sector is now the biggest risk facing China's economy in 2014 and 2015," Wang Tao, an economist at UBS Bank, said in a note.
HOW LONG WILL WEAKNESS LAST?
After a strong performance in 2013, China's real estate market has softened. Sales have slowed and banks have become increasingly cautious about lending to developers and home-buyers.
Month-on-month falls were seen in some major cities, including Shanghai and Shenzhen, which saw home prices drop 0.3 percent and 0.2 percent respectively, the NBS data showed.
Existing-home prices also dropped month-on-month in 35 cities in May, compared with 22 in April.
Analysts said a moderate adjustment in the property market will be welcomed by the government, which has spent more than four years trying to tame record housing prices amid fears of an asset bubble.
But any signs of a more serious slowdown in the property market could indicate more policy support may be needed to head off risks to the banking sector and balance the world's second-largest economy.
"We are not concerned about the likelihood of housing price collapse in China as the current turn is just a rational market adjustment," said He Qi, deputy secretary-general of China Real Estate Association.
"Housing demand remains solid in China as most Chinese still view property as one of the best investment options."
Property shares slipped after the price data, with the Shanghai property sub-index down 0.5 percent.
Recent policy tweaks at local level and government efforts to speed up lending may help the market from sliding further.
Many Chinese local governments, which badly need proceeds from land sales to pay maturing debts, have eased home-buying restrictions and made it easier in recent months for buyers to borrow from local housing provident funds.
(Editing by Eric Meijer)