China risks a more abrupt tightening in monetary policy next year after refraining from raising interest rates since October even as inflation accelerated to the fastest pace in more than two years.

Consumer prices jumped 5.1 percent in November, a statistics bureau report showed Dec. 11. A measure of wholesale costs climbed 6.1 percent, exceeding all 28 estimates in a Bloomberg News survey of economists. Even so, the central bank held off over the weekend on the rate move predicted by firms including UBS AG and Mizuho Securities Asia Ltd.

Policy makers’ hesitation may be in part a product of China’s policy of holding down the yuan, as higher returns on deposits and loans would boost prospects for inflows of speculative capital that put pressure on the exchange rate. The danger is that a quicker move to raise borrowing costs next year unsettles the expansion in the fastest-growing major economy.

“The only reason to hold back is the hot money issue,” said Shen Jianguang, a Hong Kong-based economist for Mizuho who formerly worked for the International Monetary Fund and the European Central Bank. “If they are overwhelmed by this concern and refrain from a rate hike, inflation will be a big risk next year, and then eventually they will need to rush in tightening.”

China’s central bank extended a temporary 50 basis point increase in the reserve requirements for some lenders by three months, two people briefed on the matter said today. The move, which drains money from the financial system, was in addition to an increase of the same magnitude for all lenders announced on Dec. 10.

Lending Target

The Shanghai Composite Index of stocks closed 2.9 percent higher after rates remained unchanged, paring to 11 percent the decline this year caused by investors’ concern that government tightening will damp growth and profits.

China is likely to set a target of at least 7 trillion yuan ($1.1 trillion) of lending in 2011, said two people briefed on the matter. The government also aims for 4 percent inflation, 8 percent economic growth and a 16 percent expansion in money supply, the people said, declining to be identified because the information isn’t public.

No final loan target has been set and the figure may change, one person said. This year’s goal was to limit lending to 7.5 trillion yuan. In the first 11 months the total was 7.45 trillion yuan. In 2009, lending was a record 9.59 trillion yuan.

This year’s targets are 8 percent growth -- a goal set and exceeded in each of the previous five years -- 3 percent inflation and a 17 percent increase in money supply.

Leaders’ Pledge

China’s leaders pledged yesterday to give a greater priority to stabilizing prices in 2011 and also better manage liquidity, Xinhua News Agency reported after an annual conference in Beijing to set economic policy guidelines.

The central bank has raised rates once since December 2007, pushing the benchmark one-year deposit rate to 2.5 percent and the lending rate to 5.56 percent. Across Asia, India has moved six times this year, Malaysia three times and South Korea twice.

Premier Wen Jiabao’s government has also limited gains in the yuan that could help restrain import costs, with the currency appreciating less than 3 percent against the dollar since mid-June. The yuan has fallen about 0.4 percent in the past month, trading at 6.6624 in Shanghai today.

Higher prices erode households’ spending power and make it tougher for the poorest to afford basic goods. Food prices rose 11.7 percent in November from a year before, and residence- related costs such as charges for water, electricity and rent jumped 5.8 percent. More than 81 million people in disaster- affected parts of China may need food assistance this winter, the Ministry of Civil Affairs said on its website on Nov. 18.

Capital Inflows

Meantime, officials have warned that an influx of foreign capital may contribute to asset-price pressures. Funds are flowing into China because of monetary easing in developed economies and the strength of the nation’s recovery, along with forecasts for higher rates and a stronger yuan.

Trade surpluses are also bringing in cash from overseas, with figures last week showing a $22.9 billion total for November. Liquidity is also buttressed by continued growth in credit, with banks lending 564 billion yuan last month.

“The global low interest-rate environment prevents China’s central bank from raising interest rates,” Wu Xiaoling, a former deputy governor of the central bank, said Dec. 11. She cited the risk of more capital inflows, adding that “excessive money supply is one of the important reasons for China’s inflation.”

Outstanding local-currency loans were 47.4 trillion yuan in November, 60 percent more than two years earlier, a central bank report showed last week. The M2 measure of money supply rose 19.5 percent in November from a year before.

Industrial Production

China’s November data indicated that the economy is withstanding campaigns to limit energy consumption in industry and speculation in the real-estate market. Industrial-output growth accelerated to a 13.3 percent annual pace. Retail sales advanced almost 19 percent.

Inflation may be “relatively high” in the first half of 2011 after likely easing to below 5 percent this month, the National Development and Reform Commission, the top state planning agency, said two days ago. In the first 11 months of 2010, consumer prices rose 3.2 percent, exceeding the government’s full-year target of 3 percent.

Analysts focused on the possibility of a rate increase over the weekend because of the release of the inflation data on Saturday, Dec. 11, eight days after the Communist Party’s Politburo said the nation would shift to a tighter, “prudent” monetary policy next year.

Soaking Up Cash

Instead of raising rates, policy makers have drained money from the financial system over the past two months by setting higher reserve requirements for banks. The government is also focusing on administrative measures to combat inflation and its effects, including subsidies for the poor, sales from state food reserves and, where necessary, price controls on “daily necessities.”

Rising wages are fueling inflation pressures. Yum! Brands Inc., the owner of the KFC restaurant chain, said last week that its labor costs in China may climb 10 percent or more in 2011.

Delaying the use of the interest-rates and the exchange- rate tools may lead to “a painful correction at a later stage,” said Chang Jian, a Hong Kong-based chief China economist at Barclays Capital. She saw risks including asset bubbles.

Economists anticipate a 1 percentage point rise in the key lending and deposit rates by the end of next year, according to the median forecasts in a Bloomberg survey on Dec. 2. Gross domestic product will rise 9.2 percent in 2011, the median projection shows.

Bloomberg