* China M2 growth, new loans well below forecasts
* Slowing credit growth is key to battle against inflation
* Economists still expect more tightening moves
(Adds quotes, details)
By Zhou Xin and Simon Rabinovitch
BEIJING, March 14 (Reuters) - China’s money growth and bank lending slowed sharply in February as tighter monetary policy took hold and the government made headway in its campaign to tame inflation.
Chinese banks made 535.6 billion yuan ($82 billion) in new loans in February, below market forecasts for 650 billion yuan, the central bank said on Monday.
The broad M2 measure of money supply rose 15.7 percent year on year, well shy of an expected 17.0 percent increase.
Excessive cash in the economy is a root cause of Chinese inflation, which has been running near its fastest in more than two years, so the slowdown in credit and money growth could lessen the need for aggressive policy tightening by authorities.
Economists said that Beijing was still likely to raise banks’ reserve requirements and interest rates in the near future, and keep a firm grip on loan levels throughout the year. But the data on Monday showed that its succession of tightening moves over the past half year had gained traction.
“The data shows that China’s policy measures are working,” said Ren Xianfang, economist with IHS Global Insight in Beijing.
“The central bank will be cautious in its next step, so as not to over-tighten its monetary policy as it has learnt from its policy mistakes in 2008,” he added, referring to aggressive tightening then that helped tip the economy into a pronounced slowdown.
It was the second consecutive month that bank lending had fallen short of market expectations. Chinese banks issued about a quarter fewer new loans in the first two months this year than in the same period last year.
“There has been a meaningful slowdown in money and credit growth,” Yu Song and Helen Qiao, economists at Goldman Sachs, said in a note to clients.
“This helped cool down aggregate demand growth from overheated levels in the fourth quarter, which clearly should be welcoming news as it reduces underlying inflationary pressures.”
Since declaring in October that its top priority was to control inflation, Beijing has raised interest rates three times and required reserves five times, as well as ordering banks to lend less.
China’s annual inflation in February topped expectations, at 4.9 percent from a year earlier, but that reading contrasted with dire warnings a few months ago of runaway prices.
Crucially, February’s inflation data also showed core inflation, stripped of volatile food costs, slowed.
Premier Wen Jiabao said on Monday that the government still had its work cut out in keeping inflation in check, but voiced confidence that it would prevail.
Economists and investors generally expect that new yuan loans in 2011 will be in the 7.0-7.5 trillion yuan range, although the government has not announced a loan target as in previous years.
An unprecedented surge in credit helped drive China’s recovery from the global financial crisis, but the government has struggled over the past year to get banks to return to a more normal pace of lending.
Chinese banks issued a combined 17.5 trillion yuan of new local currency loans in 2009 and 2010, almost a quarter of the economy’s total output during that time.
The surprisingly low loan figures for February followed the launch of a new, targeted system aimed at getting banks to fall in line with government guidelines on credit issuance.
Known as “dynamic differentiated reserve requirement ratios”, the central bank has forced particularly profligate banks to put a bigger share of their deposits on reserve, effectively crimping their ability to lend.
Sources told Reuters last week that the central bank had reversed some of these punitive increases, an indication of its satisfaction at the slower pace of lending last month.
Despite the clear signs of progress, economists said that China was not about to abandon its tightening bias.
“We think it’s possible for China to raise interest rates at the end of the second quarter as inflation may peak around the middle of the year,” said E Yongjian, economist with Bank of Communications in Shanghai.
“New liquidity stemming from foreign exchange inflows and the maturing of massive central bank bills, especially in March and April, will force the central bank to raise the deposit reserve ratio,” he said.
Noting that efforts to slow lending were working, Liu Mingkang, head of the China Banking Regulatory Commission, said on Monday that bad loans made to financing vehicles run by China’s local governments were under control. (Additional reporting by Koh Gui Qing and Langi Chiang; Editing by Ken Wills and Jacqueline Wong)