July 20 (Bloomberg) -- China raised interest rates for the third time since March to cool the fastest pace of economic growth in 12 years and restrain inflation.

The benchmark one-year lending rate will rise by 0.27 percent point to an eight-year high of 6.84 percent tomorrow, the People's Bank of China said. The deposit rate will increase by the same amount to 3.33 percent and a tax on interest income will be cut on Aug. 15 to encourage saving.

Premier Wen Jiabao failed to slow lending and investment fueled by record exports, propelling second-quarter growth to 11.9 percent. As well as raising interest rates, the government has ordered banks to set aside larger money reserves five times this year. Consumer prices rose the most in 33 months in June, factory and property spending have surged, and the key stock index has almost doubled in value this year.

``We view these moves as helpful but inadequate in containing overheating pressures in China,'' said Liang Hong, an economist at Goldman Sachs Group Inc. in Hong Kong. ``We continue to expect one more hike in the remainder of the year.''

The yuan fell 0.14 percent to 7.5740 against the dollar, extending its decline after the announcement, which came in the final minutes of trading. China is under pressure to allow faster currency appreciation to slow the flood of money into the economy from exports and ease trade tensions with the U.S. and Europe.

The rate increases will guide ``reasonable'' growth in money supply, lending and investment, and ``regulate and stabilize'' inflation expectations, the central bank said on its Web site.

Interest Income

The tax on interest income will fall to 5 percent from 20 percent to counter the erosion of savings by inflation, the government said.

The cut is equivalent to a 0.5 percentage point increase in deposit rates, said Frank Gong, chief China economist at JPMorgan Chase & Co. in Hong Kong.

Rising food costs pushed the inflation rate to 4.4 percent last month. That's more than returns on bank deposits, encouraging households to bet on stocks and making it harder for the government to cool the share market.

The CSI 300 Index of stocks has climbed 95 percent this year after more than doubling in 2006. The benchmark rose 4.3 percent before the central bank's statement.

``Interest rate increases have been largely priced into stock prices and digested,'' Yan Ji, an investment manager at HSBC Jintrust Fund Management Co. in Shanghai, said.

Factory Investment

Investment in factories and real estate climbed 26.7 percent in the first six months, accelerating from the 24.5 percent increase for all of 2006. The spending raises the risk of manufacturing overcapacity and idle factories if the economy suddenly slows.

``The government's top priority is to prevent the economy overheating,'' Liao Qun, chief economist at Citic Ka Wah Bank in Hong Kong, said after today's announcements. ``This will have some effect but still won't be enough.''

On May 18, the government raised rates, ordered banks to set aside larger reserves, and raised the daily amount that the yuan can fluctuate against the dollar to 0.5 percent from 0.3 percent.

China exported $112.5 billion more than it imported in the first six months, an increase of 84 percent from a year earlier.

Gains in food costs, high stock and property prices and excessive liquidity from the trade surplus ``may in combination push inflation further,'' Li Xiaochao, spokesman for the statistics bureau, said yesterday.

Currency Gains

Federal Reserve Chairman Ben S. Bernanke said yesterday that faster currency appreciation would help China's economy to shift from being ``too oriented towards exports, not enough toward home markets.'' The currency has gained 9.3 percent against the dollar since the end of a fixed exchange rate in July 2005.

M2, the broadest measure of money supply in China, rose 17.1 percent in June from a year earlier, exceeding the central bank's annual target of 16 percent for the fifth month. Banks extended 2.5 trillion yuan ($335 billion) of new loans in the first six months of 2007, already 80 percent of last year's total.

Apart from raising interest rates and ordering larger reserves, the government plans to soak up cash by selling 1.55 trillion yuan of bonds as part of setting up an agency to manage some of the country's $1.3 trillion of foreign-exchange reserves.

The National Development and Reform Commission, China's top economic planning agency, forecasts the trade surplus will widen to a record $250 billion to $300 billion this year, up from $177.5 billion in 2006.

Premier Wen called on June 13 for a ``moderate tightening'' of monetary policy, citing the pace of growth in investment and industrial production, excess money in the financial system and inflation pressures. In May, the government increased the stamp duty on share trades to cool the stock market.

The rate increase ``is a useful step forward,'' said Royal Bank of Scotland Group Plc currency strategists David Simmonds and Paul Robson and economist Kevin Gaynor in a note to investors. ``But more aggressive policy tightening is needed to prevent the economy from overheating.''

To contact the reporter on this story: Nipa Piboontanasawat in Hong Kong at npiboontanas@bloomberg.net

Last Updated: July 20, 2007 12:41 EDT