* Benchmark 7-day repo opens at 5 pct, nearly 1 pct above Wed close
* C.bank abstains from injecting funds for 3rd session
* Traders say tax payments leave them short of cash, sentiment nervous
* Positive economic data gives Beijing room to tighten up - economist
(Adds background, trader reaction, economist comment)
SHANGHAI, Oct 24 (Reuters) - China's benchmark seven-day repo rate extended its climb on Thursday after the central bank let more cash drain from the market, a move traders saw as another signal it will tighten policy.
The repo rate opened up nearly a full percentage point, at 5 percent.
The People's Bank of China (PBOC) abstained from participating in scheduled open market operations for the third consecutive session on Thursday morning, resulting in previously-issued maturing instruments draining 58 billion yuan from the country's interbank market.
The rise on Thursday followed a similar increase on Wednesday that saw short-term rates rise across the board as investors and traders considered how regulators would respond to data showing residential property prices are on a tear again, rising 9.1 percent nationwide in September.
Consumer price inflation last month was above expectations, rising 3.1 percent. Zhang Zhiwei, an economist at Nomura, said he expects inflation to rise to 3.5 percent in October, further adding pressure on Beijing to tighten policy.
An official at the PBOC told Reuters on Tuesday that the bank will likely tighten up cash supply slightly to reduce inflation and rein in credit growth, and other public statements by regulators have supported this.
GOOD NEWS AND BAD NEWS
Economists suggest two reasons for the bank to encourage mild tightening in the fourth quarter: to keep excess liquidity from aggravating inflation and housing prices, and because improving demand for Chinese products suggests rates can rise without putting growth targets at risk.
Even so, economists and traders who spoke to Reuters do not believe the bank is preparing to engineer another dramatic credit crunch like the one that occurred in the interbank market in late June, when short-term rates rose as high as 30 percent due to PBOC's unwillingness to infuse enough cash into the system to sate demand.
On Thursday, a preliminary survey showed China's manufacturing sector expanded at its fastest rate in seven months in October. The Markit/HSBC Purchasing Managers Index (PMI) stood at 50.9 in October, with the new order index rising to 51.6, well above the 50 level that separates expansion from contraction.
Zhu Haibin, chief China economist at JP Morgan in Hong Kong, argued that the tighter money environment is overdue.
"From the economic perspective, in the third quarter we had some very strong economic data, and today's flash PMI also continues to improve solidly. That will increase the determination of the PBOC for credit normalisation, for credit tapering. The policy in the last few years overall has been very loose, with credit growth way higher than nominal GDP."
However, traders said the PBOC's passivity comes even as cash demand at banks has risen to make seasonal tax payments and meet regulatory reserve requirements.
"I don't feel particularly great," said a trader at a state-owned bank in Beijing.
"Everybody just finished making tax payments - not an insignificant amount of money - but the central bank appears to be halting issuing reverse repos (which inject cash), so we are a bit worried."
Mainland stock markets, which in the past have plummeted on signs of interbank tightening, appeared to take the recent rate rise in stride, with the CSI300 index flat at midday.
The bank has drained a net 157.5 billion yuan ($25.89 billion) since the week that began Sept. 30.
($1 = 6.0835 Chinese yuan)
(Additional reporting by Chen Yixin; Editing by Richard Borsuk)