Sept. 6 (Bloomberg) -- China ordered banks to put aside more money as reserves for the seventh time this year to cool lending and investment after inflation accelerated to a 10-year high.

Lenders must park 12.5 percent of deposits with the central bank from Sept. 25, up from 12 percent, the People's Bank of China said today. The ratio is the highest in almost 10 years.

Premier Wen Jiabao said the government needs to prevent the world's fastest-growing major economy from overheating, in a televised speech minutes before the announcement. China is trying to prevent cash from record trade surpluses from driving up consumer prices and fueling asset bubbles. July's inflation rate was 5.6 percent.

``The central bank is concerned about inflation and they need to absorb the billions of dollars flowing into the country every month,'' said Liang Hong, senior economist at Goldman Sachs Group Inc. in Hong Kong.

Each 0.5 percentage point increase in the reserve ratio drains about 186 billion yuan ($25 billion) from the banking system. Local-currency deposits stood at 37.1 trillion yuan at the end of July.

The economy expanded 11.9 percent in the second quarter from a year earlier, the fastest pace in more than 12 years. The trade surplus surged 67 percent in July from a year earlier to $24.4 billion, the second-highest monthly total.

The benchmark one-year lending rate rose to a nine-year high of 7.02 percent on Aug. 22. That was the fourth increase since March.

Central Bank Signal

The Chinese economy faces ``a lot of challenges,'' including inflation, an excessive trade surplus and overly-fast investment and loan growth, Wen said in a speech to the World Economic Forum in the northern city of Dalian. Still, it can sustain its long-term growth, he said.

The central bank may be trying to signal that it's ``in control'' before next week's announcement of August inflation, said Stephen Green, senior economist at Standard Chartered Bank Plc in Shanghai. Green expects a 6 percent rate.

Increased reserve requirements ``strengthen liquidity management of the banking system and curb excessive growth of loans,'' the central bank said in a statement on its Web site.

Outstanding local-currency loans rose 16.6 percent in July from a year earlier to 25.3 trillion yuan ($3.4 trillion). Banks extended 231.4 billion yuan of new loans in July, taking the total to 2.77 trillion yuan for the first seven months.

Banks `Biggest Victims'

Commercial lenders earn only 1.89 percent in interest on required reserves, compared with a benchmark one-year deposit rate of 3.6 percent.

That means banks pay the price for China's refusal to let the yuan strengthen faster to make exports more expensive and ease the inflow of money, according to Paul Cavey, an economist at Macquarie Securities Ltd.

``In the long term, the banks will be the biggest victims of the exchange-rate policy,'' Cavey said in Hong Kong. ``With a more flexible currency, China wouldn't have to move so often to absorb the liquidity.''

China has resisted U.S. pressure to allow the yuan to strengthen more quickly. The currency has gained 9.8 percent versus the dollar since a fixed exchange rate was scrapped in July 2005. The yuan closed 0.15 percent higher at 7.5384 against the dollar in Shanghai today.

Stocks, Property

Government warnings that stocks may be overvalued haven't stopped the key CSI 300 Index from quadrupling in the past year. Households invest money in shares and property instead of watching inflation erode the value of bank deposits.

In July, housing prices jumped 19.4 percent from a year earlier in Shenzhen and 10.4 percent in Beijing. The government last month reduced a tax on interest income to 5 percent from 20 percent to make bank deposits more attractive.

Consumer-price increases aren't solely the result of ``temporary factors,'' the People's Bank of China said a monetary-policy report last month, highlighting energy and labor costs and people's expectations for inflation.

Besides raising rates and reserve requirements, the central bank has sold bills to soak up cash from record exports. Money supply grew 18.5 percent in July from a year earlier.

The nation has eased capital controls this year to let more cash flow out. The government loosened restrictions on investment abroad by fund managers, brokers and banks and approved an agency to invest some of the nation's world-record $1.3 trillion of foreign-exchange reserves.

As part of setting up the investment arm, the nation sold 600 billion yuan of bonds last month.

Individuals will be allowed to buy Hong Kong stocks under a pilot program announced last month by the currency regulator. The State Council has delayed that initiative on concerns of an exodus of funds from the Shanghai and Shenzhen stock markets, according to officials at China's banking regulator.

China raised interest rates twice in 2006 and increased lenders' reserve ratios on three occasions.

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

Last Updated: September 6, 2007 07:56 EDT