* Consumer prices fall for third month in a row
* Economists doubt central bank will respond by cutting rates
* Prices to rebound as economy recovers over course of year
* Loans down sharply but record growth in M2 money supply
By Langi Chiang and Alan Wheatley
BEIJING, May 11 (Reuters) - China fell deeper into deflation in April, but a tidal wave of money coursed through the economy on the back of an earlier surge in bank lending and cemented expectations that prices would be rising again before the end of the year.
Many economists said monetary conditions were already loose enough to fuel a recovery in China without further interest rate cuts and that a sharp decline in new lending in April put credit flows on a more sustainable footing.
Consumer prices fell 1.5 percent in the year to April, marking the third consecutive month of deflation after a 1.2 percent fall in the 12 months to March, the National Bureau of Statistics said on Monday.
Factory-gate prices fell 6.6 percent in the year to April, the rate of decline accelerating from a 6.0 percent drop in the 12 months to March.
"The central bank is unlikely to move on this pair of figures. We don't think the central bank is going to cut interest rates any time soon," said Tang Jianwei, an analyst with Bank of Communications in Shanghai.
Both falls were one-tenth of a percentage point deeper than markets had expected, but economists said the declines simply reflected a correction to spikes a year ago in the cost of food and other commodities.
"Deflationary pressure is not as severe as it looks. With the economy recovering, price changes will be back into positive territory in the second half," Tang said.
While China meets the technical definition of deflation, economists prefer to use the word to describe an economy where output and employment are shrinking and money and credit growth are shrivelling in a vicious cycle.
By this criterion, China is far from fitting the bill.
"Inflation is likely to remain in negative territory for the next few months until the base effect of high prices last year fade away, but further ahead we expect inflationary pressures to resume in response to accommodative monetary policy, strong fiscal stimulus and aggressive bank lending," said Brian Jackson, an economist at Royal Bank of Canada in Hong Kong.
RECOVERY AHEAD?
After an explosion of bank lending in the first quarter, Chinese banks pulled in the reins somewhat in April and extended 592 billion yuan of new loans, less than a third of the March total.
"It is reasonable for bank lending to ease and further easing is likely in coming months," said Zhou Xi, an analyst with Bohai Securities in Tianjin. "However, liquidity in China's banking system will remain sufficient."
The earlier lending spree still left China with annual growth of 25.95 percent in the broad M2 measure of money supply in April, the highest on record.
The People's Bank of China cut interest rates aggressively in the final months of 2008 to complement a 4 trillion yuan ($585 billion) stimulus package aimed at propping up an economy that was slumping in response to a collapse in global demand.
And, at Beijing's prodding, banks issued an eye-popping 5.17 trillion yuan in new loans in the first four months. That already tops what the government had said was its minimum target of 5 trillion yuan over all of 2009.
With an array of indicators suggesting that growth is gradually recovering, fewer and fewer economists expect further reductions in borrowing costs.
"I don't think the central bank will make major adjustments to monetary policy to combat deflation in the near term. Economic recovery is the broad consensus now," said Nie Wen with Fortune Trust in Shanghai.
Despite the general optimism, the Shanghai stock exchange lost ground to profit-taking and the main index ended the day with a loss of 1.75 percent.
Some analysts are already wondering when, instead of worrying about deflation, the central bank's thoughts will turn to inflation, given the extraordinary stimulus injected into the economy.
Jiang Chao, an analyst at Guotai Junan Securities in Shanghai, ruled out further rate cuts and said he expected inflation to average 2 to 3 percent next year.
Jing Ulrich, chairman of China equities at J.P. Morgan in Hong Kong, agreed that strong money supply growth could give rise to inflationary pressure down the road.
"However, a change in the monetary policy stance is unlikely to begin until policy makers are confident that the economy is on a clear course of recovery," she said in a report to clients. (Additional reporting by Lan Wang, Michael Wei and Simon Rabinovitch; Editing by Neil Fullick)