We all know that excessive liquidity is one of the key drivers behind China's persistent inflation and it has become a top economic priority for the central government.

Since loan growth plays an important role in market liquidity, the People's Bank of China (PBoC) has taken multiple steps to contain it since the second half of last year. However, the latest data may bring some relief to policy makers in Beijing.

According to PBoC, the country's new yuan loans reached 492.4 billion in July, in line with market expectations but significantly lower than the previous month. The sharp decline mainly reflects the effect of loan tightening policies, especially on the property sector and local financing vehicles.

Yuan loans in July grew 16.6 percent (all on a year-on-year basis unless otherwise specified), compared with increases of 16.9 percent and 17.1 percent in the previous two months.

M1 growth decelerated from 13.1 percent in June to 11.6 percent while M2 growth also mitigated to 14.7 percent from 15.9 percent in June while the M0 supply rose 14.3 percent, a similar level to the previous month. Although incremental loans remained relatively high during the past several months, M1 growth has seen a continuing slowdown from the beginning of this year, reflecting the cash-strapped situation for enterprises.

Due to the ongoing tightening policies, M1 growth is likely to remain relatively slow for the remaining months of the year. As real-term deposit rates continued to remain negative last year, both deposit and M2 growth could maintain their currently lower growth rates compared with 2010.

On the other hand, total yuan deposits showed a month-on-month decline of 669 billion yuan in July, compared to an increase of 1,910 billion in June. The decline was mainly attributable to savings and enterprise deposits, probably caused by a resurgence of the banks' off-balance wealth management products after they fulfilled regulatory requirements related to deposits in mid-year.

Due to continued loan tightening, I expect deposit growth to continue to mitigate in the second half of the year. Meanwhile, the banks are likely to continue to launch various wealth management products to attract deposit funds - and these activities will have some effects on deposit and monetary statistics.

Generally speaking, I believe recent economic figures indicate that the domestic economy should maintain robust growth despite the expected slowdown in the next few months. Meanwhile, inflation is likely to see some mitigation but it will continue to remain at a high level in the third quarter of this year.

The adjustment of housing prices is still unsatisfactory from the perspective of the central government and therefore the monetary policy will probably not loosen fundamentally in the near term.

However, recent troubles caused by the US and Europe sovereign debt problems may add uncertainties to China's economic outlook. Beijing's policymakers need some time to evaluate the impact of the external risks. Consequently, the frequency and intensity of monetary policy operations such as adjustments in reserve ratio requirements (RRR) may see an obvious decline in coming months.

The author is Executive Director of BOCI Research Ltd. The opinions expressed here are entirely his own and do not represent BOCI or any other affiliated companies within the group.

(HK Edition 08/24/2011 page2)