By Lu Jianxin and Kazunori Takada
SHANGHAI (Reuters) - Investor confidence was growing that China's credit conditions were improving as cash rates extended their fall after last week's credit crunch, and stocks rose by the most in two months on brisk buying of property and financial shares on Friday.
The central bank, which had let short-term borrowing costs spike to record highs to drive home a message to banks that they could no longer count on cheap cash to fund riskier operations, said it would ensure policy supported a slowing economy.
"China's current economic and financial operations and consumer prices are generally stable, all of which show prudent monetary policy is appropriate and producing good results," People's Bank of China (PBOC) Governor Zhou Xiaochuan told a financial forum.
Without making direct references to the cash crunch, which saw rates spike as high as 28 percent, Zhou said policy settings were appropriate and the PBOC would balance the need to reform China's economy with the need to keep growth on an even keel.
Commercial bankers have also described as exaggerated fears that they would turn off the taps on new lending after the cash crunch scare and reduce the flow of funds to the already slowing economy.
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They say the crackdown on the practice of funding riskier activities in the so-called shadow banking system with short-term cash would have little bearing on regular lending, which is determined by the amount of deposits banks attract.
Earlier this week, the central bank moved to allay fears that the crunch could escalate into a financial crisis, bringing some calm to markets after days of turbulence and heavy stock market losses, and it reiterated that message on Friday.
HALF FULL
Friday's bounce showed some investors had shrugged off their pessimism and were increasingly seeing their glass as half full, at least for now.
The index of the largest Shanghai and Shenzhen stocks closed up 1.85 percent, their biggest daily rise since April 24, buoyed by a 4 percent jump in property stocks and rebounds in smaller banks, which were hardest hit by the recent sharp sell-off.
Still, the index fell 5 percent over the week and lost 15.6 percent in June. Analysts say overall sentiment remains fragile given concerns about funding conditions ahead and China's longer-term economic outlook.
"The problems, such as excessive credit growth, shadow banking activities and local debt remain and will not go away overnight," said Ben Kwong, KSI Asia Ltd's chief operating officer in Hong Kong.
Alex Wong, director of asset management at Ample Finance in Hong Kong, said the central bank's actions and words convinced investors that Beijing even appeared ready to risk missing its 7.5 percent growth target -- a two-decade low -- to curb worrisome expansion of unregulated credit.
"The authorities sent a message to the market, and people will probably be very cautious in lending and even borrowing."
Money traders also said the market was not quite out of the woods yet, even as fears of a prolonged crunch faded.
The weighted average for the benchmark seven-day repo rate was down around 60 points to 6.16 percent -- almost half of last Thursday's record 11.62 percent, but still well above its usual range of 3-4 percent.
The overnight rate fell about half a percentage point to 4.96 percent.
"There will still be lots of cash demand in the first half of July, including the need to set aside reserves based on end-June deposits and to pay cash dividends to stock investors," said a dealer at a Chinese commercial bank in Shanghai. "Overall market sentiment remains very cautious."
(Additional reporting by Yimou Lee in HONG KONG; Writing by Tomasz Janowski; Editing by John Mair)