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By V. Phani Kumar, MarketWatch

HONG KONG (MarketWatch) — China’s consumer prices increased at their fastest pace in two years in October, strengthening expectations the central bank might continue to tighten monetary policy to curb inflationary pressures.
Cameron in Beijing on Trade Mission

Fueled by a spike in food prices, the consumer price index jumped 4.4% in October, well above the 3.6% reading in September and beating economists’ expectations for a 4% rise.

The nation’s producer price index accelerated 5% during the month, also beating estimates for a 4.6% rise and September’s 4.3% increase.

Food prices soared more than 10% during the month, while non-food price increases, although relatively modest at 1.6%, were higher than the 1.4% increase recorded in September.

“Inflation now replaces asset bubble as the top concern for policy makers, as well as investors. Beijing’s policy focus is quickly shifting to curbing inflation and containing capital flow,” said Bank of America Merrill Lynch China economist Lu Ting in emailed comments.

Lu said the central bank was now expected to raise lending rates three more times before the end of 2011, in addition to increasing banks’ reserve ratio requirements by 1 to 1.5 percentage points, allowing a 5% appreciation in the yuan and stepping up capital controls.

The government was also likely to put off increases in utility and energy prices and to maintain a loose fiscal policy despite the tightening in China’s monetary policy, he said.

China started to unwind its easy monetary-policy stance over the last month to tamp down on inflationary pressures. After raising interest rates by a quarter point and increasing reserve ratio requirements by a half-point on large banks in October, authorities also tightened foreign-exchange controls and again increased reserve requirements on some banks by a half-point this week.

At the same time, Beijing has recently begun to allow the yuan to appreciate at a faster rate against the U.S. dollar to ease inflation. Thursday, it allowed the currency to rise to a fresh record against the U.S. dollar, setting the mid-point of the greenback’s daily trading range at 6.6242 yuan, down from 6.6450 yuan on Wednesday. The dollar is allowed to move by 0.5% in either direction from the mid-point.

In a note released ahead of Thursday’s official figures, Deutsche Bank said inflation was likely to surprise on the upside in the coming two to three quarters, driven by food, rental and raw material inflation.

The brokerage said China’s CPI was likely to rise further to 4.5% in November and close to 5% in the second quarter of next year, adding that it now expected the index to rise 4% in 2011, higher than consensus estimates of 3.4%.

“Although the global liquidity environment and technical momentum remain favorable for the market in the short term, China’s inflation trend and the resulting policy uncertainty will likely become one of the few reasons for investors to turn more cautious,” Deutsche Bank’s China economist Jun Ma wrote in the report.
More data

The spike in October inflation came even as some other economic indicators softened slightly, with the nation’s industrial output increasing at a 13.1% rate from the same month last year, while retail sales expanded 18.6%. In September, industrial production had risen by 13.3%, while retail sales increased 18.8%.

Urban fixed-asset investments, meanwhile, rose 24.4% in the first 10 months of this year, also edging down from a 24.5% growth in the January-to-September period.

Chinese stocks, which fell in Shanghai and Hong Kong on Wednesday, rebounded in both markets Thursday despite the inflation data.

By late morning, the Shanghai Composite Index /quotes/comstock/16k!i:000001 (CN:SHCOMP 3,135, +19.55, +0.63%) gained 0.7% to 3,137.54, while Hong Kong’s Hang Seng Index /quotes/comstock/08s!i:hsi (HK:HANGSENG 24,768, +266.92, +1.09%) added 1% to 24,745.51.

Varahabhotla Phani Kumar is a reporter in MarketWatch’s Hong Kong bureau.