China's central bank kept up its rhetoric against inflation and excess liquidity on Friday, saying it will deploy a range of policy tools to head off inflationary pressure and asset bubbles.

Hu Xiaolian, a deputy governor at the People's Bank of China, said monetary policy in the world's second-largest economy needs to be prudent to tame inflation, which hit a 28-month high of 5.1 percent in November.

The most important task of our monetary policy next year is to steer overall money supply back to normal, Hu said at a meeting with Chinese bankers.

Bank credit expansion must be in step with main economic targets, especially when it comes to the targets for economic growth and inflation, she said.

Earlier this month, Chinese leaders said fighting inflation will be a priority for 2011 and reaffirmed a shift to a prudent monetary policy, from the previous appropriately loose stance.

Hu said the central bank will use a combination of policy tools, including interest rates, reserve requirements, and open market operations to steer policy back to normal.

The basic tone is consistent with market expectations, said David Cohen, an economist at Action Economics in Singapore. They are part of a toolkit they have been using in a multi-dimensional approach with the aim of constraining liquidity and inflation.

DIFFERENTIATED RESERVE REQUIREMENTS

Hu highlighted the importance of differentiated increases in reserve requirements for selected banks -- a tool it used twice in the three months this year sans public announcements.

The central bank will use differentiated reserve ratios in a dynamic way to supplement regular monetary tools, such as interest rates, reserve requirement ratios and open market operations.

The central bank has increased reserve requirements six times so far this year in a bid to drain excess cash from the banking system to curb inflation.

The reserve requirement ratio has reached a record high of 19 percent for some of the country's biggest banks.

The remarks will likely reinforce market speculation that an imminent rise in China's interest rates or reserve requirements is on the cards.

Many investors believe China is set to tighten policy soon in a strike against inflation, but investors are divided over whether the move will come before the end of the year.

Bank of Communications, China's fifth-largest lender, said on Friday that it expects the central bank to increase reserve requirements by at least 200 basis points next year.

A Reuters poll of 19 analysts this month showed a median forecast for the reserve requirement to hit 20 percent by the end of 2011.

The central bank's policy stance is a vote of confidence on the country's strong economic growth, which Hu acknowledged.

Overall, external demand has improved and China's economic growth momentum is on a solid ground. We will be able to maintain stable and relatively fast economic growth by implementing prudent monetary policy.

(Reporting by Zhou Xin, Kevin Yao, Langi Chiang and Koh Gui Qing; Editing by Benjamin Kang Lim, Ron Askew)

China Inflation