UPDATE 1-China's July factory gate inflation holds steady, consumer prices ease

ease@ (adds details, analyst comment, context on economy & policy)

BEIJING, Aug 9 (Reuters) - China's annual producer price inflation held steady in July, with prices for key raw materials up slightly on expectations of deeper capacity cuts going into the winter months of heavy pollution, while consumer inflation slowed slightly.

The producer price index (PPI) rose 5.5 percent last month from a year earlier, unchanged from June, the National Bureau of Statistics (NBS) said on Wednesday.

China's economy has posted solid growth this year as commodity prices recovered, helping boost the industrial sector, while mild consumer price gains have left policymakers room to maneuver should growth falter.

Analysts polled by Reuters had expected producer prices to hold steady for a third straight month at 5.5 percent.

On a month-on-month basis, the PPI rose 0.2 percent in July, after three months in the red, with the NBS attributing this to a rise in prices of commodities including steel and non-ferrous metals.

Prices of commodities futures including steel rebar began to rise again in June and have continued to surge through early August, underscoring concerns over tight supply amid pollution inspections and strong restocking demand.

China has eliminated around 120 million tonnes of low-grade steel capacity and 42.39 million tonnes of crude steel capacity in the first half of the year, equivalent to 84 percent of its target for the whole year.

Weaker factory price inflation could start to weigh on profits at China's large - and often heavily indebted - industrial firms, who have benefited from a strong commodities reflation cycle over the last year.

Chinese policymakers have clamped down on expansion of the money supply, and broad credit growth has also moderated, which could weigh on any further industrial recovery in China.

"The current level of consumer inflation is so mild that the PBOC will be comfortable resuming the deleveraging process in the financial sector," Iris Pang, ING economist wrote in a note ahead of the data.

"We expect the central bank to keep liquidity either as tight as in July or even slightly tighter, and push interbank interest rates higher, especially at the short-end to reduce leveraging activities by interbank participants, which include banks and non-bank financial institutions."

China's consumer price index slowed slightly to 1.4 percent in July from a year earlier, missing market expectations, the NBS said.

Food prices, the biggest component of the consumer price index (CPI), fell 1.1 percent from prior year.

Analysts had expected July consumer inflation to have remained unchanged at 1.5 percent for the third month in a row.

China has set its inflation target at 3 percent and economic growth of around 6.5 this year, which suggests policy makers still have room to tighten controls to rein in financial risks from years of debt-fueled stimulus.

(Reporting by Sue-Lin Wong and Min Zhang; Editing by Shri Navaratnam)