Yuan role limited in China inflation fight: central bank head

BEIJING (Reuters) - The yuan plays only a secondary role among China's options to temper inflation, and monetary policy alone won't be enough to rein in prices, central bank governor Zhou Xiaochuan said on Friday.

The People's Bank of China will use a mix of banks' required reserves and interest rates as well as open market operations to mop up excessive cash, Zhou told a news conference during the annual parliament session.

"China's economy is very large and so is its population. So we can say that changes in the exchange rate will have some impact on domestic prices, but the impact will not be that big compared with that in smaller, open economies," Zhou said.

"Against that backdrop, the main policy tool used to manage inflation is not the exchange rate," he added.

Outside economists have long said that faster yuan appreciation would help China blunt imported inflation stemming from soaring commodity prices, but Zhou's comments made clear that the central bank does not quite see it that way.

He sidestepped a question about how much the yuan will be allowed to appreciate this year, but he reiterated the long-standing policy of keeping the currency "basically stable" while reforming the currency regime to make it more market-driven.

China has let the yuan rise about 3.8 percent since it was depegged from the dollar in June 2010. Most analysts have penciled in a 5-6 percent rise this year.

China's anti-inflation efforts are not restricted to monetary policy, said Zhou, who has been central bank governor since 2002 and is likely to be replaced next year.

"Monetary policy needs to coordinate with fiscal policy and structural policies," he said.

Zhou also played down expectations that China's negative real interest rates could disappear anytime soon.

"It's possible that interest rate changes will not be as fast as inflation, so we may see a period of negative real interest rates," he said.

China's annual inflation topped expectations in February at 4.9 percent and looks set to climb further in the comings months, adding to pressure for another dose of monetary tightening.

China has raised banks' reserves requirements eight times since early 2010 and has increased interest rates three times since October.

"Interest rate policy will definitely be an important tool, but it could lead to more capital inflows as every policy instrument has its side effect," Zhou said.

As for banks' reserve requirements, Zhou said the central bank had been forced to use the policy tool to mop up liquidity due to the rapid expansion of base money in the economy.

"If base money normalizes and comes under control, we will not need to rely more on banks' reserve requirements to adjust liquidity," he said.

(Reporting by Kevin Yao; Editing by Ken Wills)