Growth in Chinese investment and factory output slowed further last month as the government brought credit growth back to normal after a record lending spree in 2009 to counter the global financial crisis.

The figures, along with weaker retail sales, add to the picture of softening domestic demand painted on Tuesday by a sharp drop in import growth.

Industrial output continued to ease, indicating a moderation of economic activities. But a sharp slowdown in economic growth can be ruled out, because resilient household consumption will help compensate for a drop in investment, said Zhu Baoliang, a researcher with the State Information Center, a government think tank in Beijing.

Annual factory output growth slowed to 13.4 percent last month from 13.7 percent in June but beat forecasts of a 13.2 percent rise.

Year-to-date growth in investment in fixed assets such as flats and factories in urban areas slowed to 24.9 percent from 25.5 percent, undershooting forecasts of a 25.2 percent rise.

However, after taking into account wholesale inflation, which dropped to 4.8 percent in the year to July from 6.4 percent in June, real growth on the month was steady, according to Ting Lu, an economist at Bank of America Merrill Lynch.

China's growth is slowing, but we see no sign of a hard landing, he said.

TOO RESTRICTIVE

Sheng Laiyun, a spokesman for the National Bureau of Statistics, which released the data, also struck a note of calm.

He described the slowdown as moderate and a welcome step to a more sustainable model of growth that relies less on energy-intensive heavy industry. China this week ordered the closure of more than 2,000 obsolete, fuel-guzzling factories, steel mills and cement works.

Some economists, though, were less sanguine.

Yu Song and Helen Qiao, economists at Goldman Sachs, pointed to a moderation in annual retail sales growth to 17.9 percent in July, from 18.3 percent in June, that fell short of projections of an 18.3 percent increase.

A slowdown in growth of money supply, the lubricant of every economy, was particularly alarming, they said in a note.

Annual growth in the broad M2 measure of money slowed to 17.6 percent from 18.5 percent in June, a rate that economists had expected to be repeated in July.

We believe this level of broad money supply growth is clearly too restrictive as it will put more downward pressure on domestic demand growth in the near future, Yu and Qiao said.

There are also question marks next to overseas demand.

Although figures on Tuesday showed stronger-than-expected exports, the Federal Reserve warned overnight that the pace of the U.S. recovery had slowed.

China is also concerned about the fragility of demand from Europe, which is drowning in debt.

NO RELAXATION

If growth does continue to soften, some economists believe the government could speed up targeted investments in areas such as low-income housing, rural development and clean energy.

Another option would be to relax this year's loan quota of 7.5 trillion yuan, down from a record 9.6 trillion last year.

Tao Wang, UBS's China economist, said there was no reason for a knee-jerk easing. The slowdown is still moderate. If people were looking for policy relaxation, they would be disappointed from this set of numbers, she said.

New loans in July alone totaled 533 billion yuan, the central bank said, below forecasts of a 600 billion increase.

Zhu, the State Information Center researcher, said the government would not water down the full-year target.

It will not relax efforts to control lending growth, even though the economy is slowing, he said.

Beijing is particularly anxious to take the air out of an inflated property market.

Fearing that prices were feeding on themselves, Beijing increased down payments and mortgage rates, made it tougher to buy multiple homes and tightened financing for developers.

The curbs are sapping demand for everything from steel to sofas. But apartment prices in major cities, while no longer rising, are still beyond the reach of ordinary people -- an incendiary issue for the ruling Communist party.

While the case for loosening policy is not clear-cut, the consensus is that Beijing has no cause to tighten either, even though inflation rose back above the government's 3 percent target in July.

Consumer price inflation accelerated to 3.3 percent, in line with forecasts, from 2.9 percent in the year to June, but economists said the jump was the fleeting result of widespread flooding across China that has boosted food costs.

Overall, economists are confident that gross domestic product growth for all of 2010 will beat last year's outcome of 9.1 percent and catapult China ahead of Japan as the world's second-largest economy after the United States -- a ranking that, by some calculations, it has already been secured.

(Additional reporting by Langi Chiang and Aileen Wang; Writing by Alan Wheatley; Editing by Ken Wills and Jonathan Thatcher)

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