China's consumer prices are beginning to stabilize and could bottom out at the end of the third quarter before rebounding, the central bank said yesterday in a report.

The report, released by the statistics department of the People's Bank of China, said that inflationary expectations were beginning to emerge and that inflationary pressures from imports were also building up.

"China's growth recovery in the second quarter had been stronger than expected, hitting 14.9 percent on an annualized, seasonally-adjusted basis," said the report.

The consumer price index (CPI) fell 1.7 percent in the year to June. Yet, despite a negative CPI, investors' expectation of a rising inflation rate scenario as early as the fourth quarter or the beginning of next year was increasing, driven by huge credit supply in the first half as part of the government's stimulus plan to boost the economy.

The central bank said yesterday that a slowdown in new infrastructure projects might reduce the demand for new loans while demand for property development might rise in the coming months.

New loans extended by Chinese banks last month hit 1.53 trillion yuan, pushing cumulative first-half lending to 7.37 trillion yuan, far exceeding the government's 5-trillion-yuan target for the entire year.

"Part of the new lending in the first quarter has been used for speculative purposes instead of investment," Hu Yuexiao, an economist from Shanghai Securities said, adding that great uncertainty on the real economy has prevented investors from investing in industries.

Some officials and analysts estimate that one-fifths of the new lending has found its way into stocks, property and other asset markets, pushing China's benchmark stock index to jump more than 80 percent so far this year.

The central bank report yesterday revealed that the index reflecting wishes to own stocks rose to 52.3 percent in the second quarter, compared to 18.6 percent in the last quarter.

Another major source of liquidity was a renewed surge in China's foreign exchange reserves, which jumped $177.9 billion in the second quarter to $2.13 trillion -- a clear sign that speculative money is flowing into the country again.

He Fan, an economist at the Chinese Academy of Social Sciences, a top think-tank in Beijing, said the economy was awash with liquidity, which had increased the risk of an asset bubble and could fuel inflation.

"In the second half, China should change its policy direction in a timely fashion," he told Reuters. "It needs to adjust the overly loose monetary stance, while sticking to its active fiscal policy."