China easily beat its 2009 growth target after a blistering fourth quarter performance that set the stage for further monetary tightening and put it on course to overtake Japan to become the world's second-largest economy.

Gross domestic product surged 10.7 percent between October and December, compared with a year earlier, a tad below market forecasts of 10.9 percent, but up sharply from a revised 9.1 percent in the third quarter.

China's fastest quarterly growth in two years raised expectations that Beijing will lift interest rates sometime in next few months after a series of smaller steps taken to contain buoyant lending and prevent the economy and its markets from overheating.

Obviously the month-on-month growth momentum is very strong, said Xing Ziqiang, an economist at CICC in Beijing. So I think the chances for us to see an interest rate rise in the first quarter are increasing.

For all of 2009, the economy grew 8.7 percent. That handily exceeded the official target of 8 percent, a goal deemed the minimum needed to create jobs and preserve social stability.

That has instilled confidence in markets and consumers and paid off with growth becoming more robust and broad-based.

Confidence is the spark setting fire to the plain, Ma Jiantang, head of the National Bureau of Statistics, told a news briefing.

The data prompted JPMorgan and RBS economists to lift their 2010 growth forecasts to 10 percent from 9.7 percent and 9.5 percent respectively, but expectations of policy tightening outweighed optimism about China's contribution to global recovery.

The U.S. dollar <.DXY> briefly rose to its highest in four months after the Chinese figures, as investors cut their exposure on riskier bets. Shares in most of Asia-Pacific eased, though stocks in Shanghai <.SSEC> were up 0.3 percent.

The fourth-quarter flourish was flattered by a low base of comparison in the same period a year earlier, when China's export-orientated economy was dragged down by the global financial crisis, costing more than 20 million migrant workers their jobs.

But the double-digit growth is also testimony to the government's rapid response to the downturn.

A 4 trillion yuan ($585 billion) fiscal stimulus package was complemented by an unprecedented surge in lending by the nation's predominantly state-owned banks, ensuring that China was the first major economy to recover decisively from the credit crunch.


Indeed, banks have been lending so freely of late that policymakers have turned their attention to nipping inflation in the bud.

The statistics bureau, which released the GDP figures, also reported that consumer prices rose 1.9 percent in the year to December, a marked acceleration from November's reading of 0.6 percent.

Alarmed by a new burst of credit at the start of January, the central bank last week increased the proportion of deposits that banks must hold in reserve, rather than lending out, and followed through this week by ordering some of them to sharply curtail lending for the rest of the month.

The central bank has also been lifting yields on its bills over the past few weeks and on Thursday nudged up the yield on three-month bills for the second time this year.

So far China has resisted international pressure to let the yuan resume its rise after an 18-month pause, but expectations are growing that Beijing will relent in coming months.

Yuan appreciation is likely to resume in March or April, though the rise will be gradual, say about 3-5 percent a year, said Xing at CICC.

A stronger exchange rate would dampen inflation and encourage domestic demand, thus helping to rebalance the Chinese as well as the global economy.

China has taken a slew of steps to spur spending, including subsidies for rural buyers of domestic appliances and tax breaks on fuel-efficient cars, a measure that helped China to overtake the United States in 2009 as the world's largest car market.

Retail sales grew 17.5 percent in the year to December, accelerating from 15.8 percent in November and compared with forecasts of a 16.4 percent rise.

Industrial production growth slowed to 18.5 percent from 19.2 percent, undercutting market forecasts of a 20.0 percent increase.

Growth of 8.7 percent in 2009 fell short of the previous year's rate of 9.6 percent, but economists polled by Reuters expect a rebound this year to around 9.5 percent.

That would be enough for China to relegate Japan to number three in the world economic rankings. Goldman Sachs expects China to eclipse the United States as the biggest economy in the world by 2027.

(Reporting by Zhou Xin and Chris Buckley; Writing by Alan Wheatley and Kevin Plumberg; Editing by Tomasz Janowski)