China's import growth fell sharply to its slowest pace in 20 months in June in further evidence of the broad impact of monetary tightening on the economy, while a wider trade surplus suggested capital inflows will remain a challenge for authorities.

The substantial drop in June import growth, which decelerated to a 19.3 percent annual pace from May's 28.4 percent, is bound to heighten investor concerns about how swiftly the world's second-largest economy is slowing.

But, coming a day after data showed June inflation hit a 3-year peak, analysts took the jump in the trade surplus as a sign that China might have to raise rates further, both to rein in prices and to combat capital inflows.

The trade surplus surged in June, said Liu Li-Gang, an economist with ANZ. We would interpret this to mean the moderation in export and import growth is not big enough to prevent the government from tightening further.

The big trade surplus means PBOC will continue to experience large capital inflows. The PBOC will have to address this inflow problem, so it's unlikely they will pause monetary policy.

A slew of indicators in the past few weeks have pointed to a moderation in the heady pace of China's growth, from purchasing manager surveys of new orders to Taiwan's exports to the mainland.

But the People's Bank of China has made clear inflation remains a priority for policy. Most analysts agree the resultant growth from that policy mix will be slower than the near double-digit pace of the past few years but there is little risk of a hard landing.

The government is due to announce second-quarter economic growth data on Wednesday.

Imports were below expectations, noted David Cohen, an economist at Action Economics in Singapore. We are perhaps seeing some reflection of loss of momentum in China's growth. After all, there has been tightening in policy.

The numbers are consistent with decelerating growth, with the soft landing that many people are looking for.

Last week, the central bank raised interest rates for the third time this year, underlying the government's confidence in the economy's ability to cope with tighter monetary policy.

Sunday's data showed June exports rose 17.9 percent from a year ago, slowing from a 19.4 percent rise in May and pointing to the weakness in overseas demand that has seen exports and new orders soften across most of Asia.

Exports hit a record high of $162 billion in June, while imports for the month were $139.7 billion. That left the country with a trade surplus of $22.3 billion in June, compared with $13.1 billion in May.

The median forecast of economists polled by Reuters was for exports to rise 18.7 percent and imports to grow 25.0 percent, resulting in a trade surplus of $16.3 billion.

On a calendar-adjusted basis, exports expanded 16.4 percent in June from a year earlier, while imports jumped 19.2 percent, the customs agency said.

Exports rose 3.1 percent in June from May, while imports fell 3 percent month-on-month. On a calendar-adjusted basis, June exports rose 4.2 percent from May, while imports fell 2.6 percent from May.

POLICY PAUSE COMING?

China's inflation data has become its most closely-watched indicator in recent months as investors look for clues on whether Beijing is about to shift its policy stance after nine months of steady tightening.

The consumer price index for June rose 6.4 percent from a year earlier, slightly above economists' forecasts for a 6.3 percent increase, with sharp rises recorded in food, consumer goods and property.

Worryingly, there were signs that inflation pressures were spreading and may persist even if global commodity prices continue to fall. Non-food prices climbed 3 percent in their biggest jump since records began in 2002.

Analysts are concerned that record pork prices, a key driver of China's food inflation in recent months, are also unlikely to ease anytime soon -- a view shared by pork producers due to a pig shortage.

China has raised rates five times since October, alongside nine increases in the required reserve ratio for banks. Several economists think Beijing has already fired its pre-emptive shot at inflation and is near the end of its policy tightening.

Indeed, China's stock market has risen and onshore swaps too have increasingly priced in chances that policy rates have peaked.

A slim majority of analysts surveyed by Reuters this week thought China would raise rates once more this year before standing pat until June 2012.

REBALANCING

At the same time, Beijing has repeatedly vowed to restructure its economy, cutting its reliance on exports and investment, and promoting domestic consumption in their place. As a result, import growth has become a bellwether for the strength of Chinese demand.

A slowdown in China's export growth had been anticipated in response to the slowing U.S. economy and as factory growth in Asia and Europe slid to multi-month lows in June.

For the second half of the year, we expect exports to continue to fall due to the impact from the European debt crisis, Japan's earthquake and other factors, said Tang Jianwei, an economist at Bank of Communications in Shanghai.

The surplus in June was the highest in seven months. China's trade surpluses have fueled criticism from key trade partners who accuse Beijing of giving its exporters an unfair boost with a cheap currency.

Despite the latest data, China's trade surplus is on track to narrow for a third straight year from last year's $183 billion as the government tries to rebalance the economy in favor of domestic consumption, cutting reliance on exports.

The trade surplus will be maintained in the second half of the year, but domestic demand is still relatively strong. So we are expecting a full-year surplus of $100 billion, Tang added.

(Additional reporting by Zhang Shengnan; Editing by Ken Wills and Vidya Ranganathan)

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