China should hasten the liberalisation of its interest rate market to rein in accelerating inflation in the world's second-biggest economy, a senior Chinese central bank official said on Wednesday.

Sheng Songcheng, the head of statistics at the People's Bank of China, said Beijing should lift the ceiling on deposit rates as it reforms the nation's financial markets by easing government control.

Higher deposit rates will favor savers and drain the market of excess cash, seen by many as the main driver of inflation, which hit a 28-month high of 5.1 percent in November.

China should allow the upward floating of deposit rates. It will gradually enable the market to price in expectations on interest rate rises, he said in an article published on the central bank's website. www.pbc.gov.cn

That will help change the negative real deposit rates and curb inflation.

Beijing controls China's interest rate market by setting a ceiling on deposit rates and a floor on lending rates. This protects banks from competition and ensures they have a decent interest rate margin, which is around three percentage points now.

Public discontent over rising prices in China has led the Chinese government to adopt a tough anti-inflation stance. The nation's top leaders have said repeatedly that taming inflation is among their top priorities next year.

Sheng said the central bank should consider asset prices and China-U.S. interest rate differentials when setting monetary policy.

Speculative demand in China's property market has pushed prices to record peaks. This increasingly worries the government as high consumer prices have stirred social unrest in the past.

The central bank should not only pay close attention to prices of general goods, but also asset prices, Sheng said.

Price changes in the stock and property markets affect Chinese people's wealth. Asset prices should become an important variable when setting our monetary policy, he said.

But that said, Sheng warned China to heed its growing rate premium over the United States as that is attracting speculative funds into the country and fuelling price pressures.

China's benchmark one-year deposit rate stands at 2.75 percent, well above near zero rates in the United States.

With widespread market expectations that China will further tighten monetary policy in 2011 to calm inflation -- it raised rates by 25 basis points on Christmas Day -- the rate differential could widen even more.

Many domestic academics are worried that interest rate rises may accelerate global speculative inflows into China, he said.

(Reporting by Langi Chiang and Koh Gui Qing; Editing by Ruth Pitchford)

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