* 10-year government bond yields at 8-year high
* Market expects interest-rate reform to raise funding costs
* Spike in rates forces firms to delay bond sales
* Policymakers seek de-leveraging to avoid debt crisis
SHANGHAI, Nov 21 (Reuters) - Chinese bond yields have surged as the market starts pricing in interest rate reform, a development that makes borrowing more expensive and threatens China's fragile economic recovery.
Chinese bond prices have been hammered in recent days on expectations that reforms to loosen government control of interest rates will cause funding costs to rise. Bond prices move inversely to interest rates so when bond prices fall, their yields rise.
The yield on benchmark 10-year government bonds closed at 4.72 percent on Wednesday, the highest level since March 2005 and up from 3.42 percent in late May.
"Interest rates are on an uptrend because the market is pricing in expectations of deposit-rate liberalization and higher funding costs for commercial banks," said Patrick Wu, head of China trading at J.P. Morgan in Shanghai.
In a detailed policy statement published last week following a key Communist Party meeting, leaders pledged to accelerate financial reforms, including freeing up controls on interest rates.
In comments published in a "study guide" to the reforms announced after the party meeting, central bank governor Zhou Xiaochuan said that China would achieve full interest-rate liberalisation in the medium term.
Yields began their rise in October, as expectations built that the party meeting would produce major reforms. At least 20 firms have postponed planned bond issuances this month due to the weak market, the official Shanghai Securities News reported on Thursday.
"When you look at the corporate bond market issuance plan at the end of this year, I don't see any big state-owned enterprises coming to issue. And for the AA (rated) or below issuers, there's limited demand in the market," said Wu.
Indeed, the spread between five-year AA rated medium-term notes and risk-free government bonds hit 246 basis points on Wednesday's close, the widest since June 2012. Benchmark yields on such paper hit 6.98 percent, the highest in at least a year.
MORE EVIDENCE OF A SQUEEZE
In further evidence that corporate financing is getting squeezed, credit data released last week showed a slowdown in bank lending and other financing channels in October.
Despite the short-term hit to growth, less credit may be a welcome sight for policymakers, who have emphasized the need for de-leveraging.
Rating agency Fitch has estimated that China's ratio of total debt-to-GDP, including government, corporate and household debt, will reach 218 percent of GDP by the end of 2013, up 87 percentage points since 2008. In July, the International Monetary Fund warned that similarly rapid debt run-ups have been associated with financial crises in other countries.
China's economy grew by 7.8 percent in the third quarter, up from 7.5 percent in the second quarter. But a preliminary survey released Thursday showed that growth of China's factory sector slowed in November, bolstering expectations the economy could lose some of its vigour in the fourth quarter.
The People's Bank of China has also engineered a rise in short-term cash rates by withdrawing liquidity from the money markets via open market operations in recent weeks..
After withdrawing funds for four of the last five weeks, the PBOC conducted its largest weekly net injection since September this week, but short-term rates ticked up further and traders say liquidity remains tight.
(Editing by Richard Borsuk)