Chinese inflation was lower than expected at 4.9 percent in the year to January, but price pressures continued to build and will force the central bank to stick to its course of monetary tightening.

Economists polled by Reuters had forecast a 5.3 percent rise in the consumer price index (CPI) following a 4.6 percent increase in the year to December.

Though the market cheered the softer-than-expected CPI, it may provide a false dawn and should be considered with caution mainly because recent indicators and developments still signal that upside risk to inflation persists, said Connie Tse, economist at Forecast PTE in Singapore.

In one sign of the accumulating pressures, core inflation, stripped of volatile food prices, jumped to 2.6 percent year on year from 2.1 percent a month earlier.

In another sign, producer prices rose 6.6 percent in the year to January, accelerating from an increase of 5.9 percent in the 12 months to December and well above the 6.1 percent rise forecast by analysts.

The National Bureau of Statistics also announced a major change in the way it calculates consumer price inflation. Housing was given a much larger share of the new CPI basket, while the weighting of food prices was reduced.

Many in the market had expected that the adjustment, conducted every five years, would lower the CPI, but the statistics agency said the adjustment had actually added 0.024 percentage point to January's reading.

February CPI is expected to be about 5.2 percent, and if it is significantly lower than that, we may conclude that inflation in China has changed fundamentally. Or we can say that the CPI indicator itself is quite doubtful in terms of reliability, said Gao Shanwen, chief economist with Essence Securities in Beijing.

RECEDING PRESSURE?

But at least some investors and analysts took the statistics agency at its word, and said that lower inflationary pressure would reduce the need for aggressive tightening.

China's main stock index was up a little on Tuesday after soaring 2.5 percent a day earlier when rumors of the inflation data spread through the market.

Ting Lu, an economist with Bank of America-Merrill Lynch noted that the biggest surprise was the 10.6 percent increase in food prices year on year. Many had thought a larger rise was in store, because the Chinese New Year fell earlier in 2011 than 2010 and that was expected to push up food costs in January.

The implication here is that inflation pressure might be smaller than the market had thought, he said.

Last week, the central bank raised interest rates for the second time in just over six weeks, indicating that risks are tilting toward more aggressive monetary tightening than investors expect.

Trying to mop up the excess cash in the economy that has fueled inflation, Beijing has also raised banks' required reserves seven times since the start of last year and ordered them to issue less credit.

(Additional reporting by Kevin Yao and Aileen Wang; Editing by Ken Wills)

China Inflation