China's bank lending and money growth expanded faster than expected in June as loan demand remained buoyant, adding to the case for further monetary policy tightening.

Coming days after news that China's inflation hit a three-year peak in June, Tuesday's data also showed the country's foreign exchange reserves soaring to a record $3.2 trillion at the end of the second quarter.

The build-up in reserves, which threatens to worsen China's inflation headache, argued for Beijing to leave its foot on credit brakes and further raise interest rates, some analysts said.

Loan demand from the economy is still strong, which could reduce some worries about a hard landing, said Du Zhengzheng, an analyst at Bohai Securities in Beijing.

We expect the central bank to raise interest rates once or twice more this year.

Worried that rising prices could trigger social unrest, China has declared that fighting inflation is its top policy priority.

It has for months restricted bank lending to slow it from the extraordinary pace seen in 2009, when a surge in government spending fueled a borrowing binge.

But the latest data showed loan demand has defied Beijing's clampdown by staying resilient. Banks lent close to 634 billion yuan ($98 billion) in new yuan loans in June, the central bank said, beating the forecast for 590 billion yuan and above May's 552 billion yuan.

Annual growth in China's broad M2 measure of money supply also quickened to 15.9 percent in June from May's 15.1 percent, and above forecasts for 15.2 percent.

Only annual growth in outstanding yuan loans met expectations at 16.9 percent.

For a graphic on China's bank lending, please click on http://link.reuters.com/vec62s

New loan growth continues to register a strong increase, said Paul Tang, chief economist at Bank of East Asia in Hong Kong.

The People's Bank of China will continue to keep a close watch on credit growth. The government will need to keep up its tightening stance in the second-half of the year.

SLOWER OFFICIAL LENDING

Bank lending is a focal point in China's monetary policy as it is controlled by Beijing through loan quotas to manage economic growth and control inflation.

Under the weight of tighter policy, Chinese banks have lent 4.1 trillion yuan worth of new yuan loans since January, about 11 percent lower than that seen in the first half of 2010.

That compares with an informal lending target of between 7-7.5 trillion yuan that many believe Beijing has set for banks this year.

To be sure, the pull-back in official bank loans belies buoyant lending that banks are hiding outside their balance sheets.

But the modest slowdown in official bank lending has already fueled complaints of a credit squeeze among smaller firms, leading some analysts to predict China may selectively ease credit restrictions in coming months.

The credit quota restrictions will be loosened a little in the second-half of the year, particularly for small- and medium-sized enterprises, said Ren Xianfeng, an economist with IHS Global Insight in Beijing.

TOO MUCH LIQUIDITY

To cool prices, Beijing has pulled a range of levers to tighten policy in the past year: it has ordered banks to lend less; let the yuan rise on the dollar, and raised interest rates and banks' required reserve ratio.

But inflation is still proving stubbornly high. It hit 6.4 percent in the year to June as food, consumer goods and property prices jumped.

While some analysts believe China's inflation could start to cool in coming months when global commodity prices fall, critics argue Beijing's inflation battle is far from over since the country is still awash in liquidity.

Some analysts say China's ballooning reserves, far from being a symbol of growing wealth, underscore its problem of excess cash, which they believe is the root cause of its inflation woes.

The increase in foreign exchange reserves does complicate the monetary policy, said David Cohen, an economist at Action Economics in Singapore. That's why we've seen the repeated raising in the reserve retirements as a way to absorb the increased liquidity.

Cohen said he expects Beijing to raise interest rates once more alongside further increases in banks' required reserves.

In the second quarter, China's foreign exchange reserves added another $153 billion, helped by a gaping trade surplus and Beijing's buying of dollars to hold down the yuan.

Although the rise in reserves was smaller than forecasts for $175 billion gain, it was still a sizable addition to the world's largest stash of foreign exchange reserves.

(Additional reporting by Aileen Wang and Beijing Newsroom; Editing by Ken Wills and Richard Borsuk)

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