China's economy made a strong start to the year, according to a pair of business surveys released on Monday that also underlined the mounting challenge policymakers face to curb inflation.

An index based on an official survey of purchasing managers last month eased from a 20-month high in December but remained firmly in expansionary territory, while an index derived from a companion poll by HSBC scaled an all-time high.

What the two reports did have in common was evidence of a further increase in cost pressures. In the case of the HSBC survey, prices that industrialists paid for their raw materials and charged to their customers rose at the fastest pace since July 2008.

Industrial activity continues to accelerate, implying stronger GDP growth in the first quarter. But rising input and output prices also point to greater inflationary pressure, which will likely prompt more tightening measures in the coming months, said Qu Hongbin, chief economist for China at HSBC.

China might increase interest rates once consumer inflation exceeds the one-year benchmark deposit rate of 2.25 percent, Ba Shusong, a prominent government adviser, told Reuters. Consumer prices rose 1.9 percent in the year to December.

But in an illustration of the uncertainty surrounding Chinese policy at this juncture, a central bank researcher suggested that tightening could take the form of stiffer reserve requirements rather than higher interest rates.

A half-point increase in required reserves that took effect on January 18 locked up 300 billion yuan. World markets tumbled in response to the tightening, which occurred much earlier than investors had expected.

Whether China will increase interest rates or not will be decided by the price situation, and prices in the first quarter won't be too high, Jiao Jinpu, deputy head of the central bank's postgraduate school, told the official China Securities Journal.

LENDING SLOWDOWN

The Economic Information Daily, which is published by the official Xinhua News Agency, said that the central bank would rely more heavily on quantitative and administrative tools, not interest rate increases, to control lending.

Illustrating the forcefulness with which one-party China can implement such measures, figures provided by the paper pointed to a sharp slowdown in lending in the last 10 days of January after regulators ordered banks to pull in their horns.

Banks lent 1.1 trillion yuan in the first half of January, according to bankers familiar with the central bank; by January 19, the total had reached 1.45 trillion yuan, local media reported.

But for the whole of January net new lending was less than 1.6 trillion yuan ($234.4 billion), the Economic Information Daily reported, without giving a source for its information.

If the figure is confirmed when the People's Bank of China releases official data next week, it will mean that net lending last month was actually lower than the January 2009 total of 1.62 trillion yuan. Beijing has set a loan quota for all of 2010 of about 7.5 trillion yuan.

The Shanghai Composite Index ended 1.6 percent lower on lingering concerns about tightening market liquidity.

Until recently, Chinese policymakers had bent all their efforts on pulling the world's third-largest economy out of a downturn induced by the global financial crisis.

The message from Monday's surveys of purchasing managers was that, with the economy now back at cruising speed after growing 10.7 percent in the fourth quarter from a year earlier, Beijing is now justified in paying more attention to rising prices.

The increase in the input prices component adds to recent evidence of heightened inflationary pressures, reinforcing the case for policy tightening in the months ahead, said Brian Jackson, a strategist with Royal Bank of Canada in Hong Kong.

Both reports also showed strength in export orders, suggesting a further improvement in global demand going into 2010.

HSBC's Purchasing Managers' Index (PMI) rose to a record high of 57.4 in January from 56.1 in December, while China's official PMI fell to 55.8 from 56.6.

It was the first month-on-month deterioration in the official index since May 2009, but it remained firmly above the threshold of 50 that demarcates expansion from contraction.

($1=6.826 Yuan)

(Reporting by Alan Wheatley, Aileen Wang and Zhou Xin; Editing by Neil Fullick)

China HSBC Inflation Price