China's economic growth may further slow in the first quarter to 8.5 percent, from 8.9 percent in the fourth quarter of 2011, with the potential risks of a sharper global deterioration and a sudden domestic property downturn raising the government's concerns about policy changes, a senior economist from the State Council's think tank said on Thursday.

GDP growth for the full year is likely to reach 8.5 percent, above the government's target of 7.5 percent, despite a "combination of shrinking short-term demand and falling long-term potential productivity", said Yu Bin, director-general of the Department of Macroeconomic Research Center of the State Council.

Potential risks arise from a deepening export drop as the European debt crisis intensifies and the real estate sector cools down, Yu told a news conference.

A preliminary gauge of domestic manufacturing sector operating conditions - the HSBC Flash Purchasing Managers Index - declined to a four-month low of 48.1 in March, compared with 49.1 in February, according to HSBC Holdings Plc.

A reading below 50 means economic contraction; one above 50 indicates expansion.

"Growth could slow further amid a combination of sluggish new export orders and softening domestic demand," Qu Hongbin, chief economist in China and co-head of Asian economic research at HSBC, wrote in a research note.

In addition, the sub-index of employment fell to its lowest since March 2009, indicating that slowing manufacturing production was hindering companies' hiring plans, said Qu.

The situation "calls for further easing steps from the government", Qu said.

The government has room to adjust policies according to the changing global economic climate, while reduced inflation pressure is providing room for monetary policy easing, said Yu.

Surging fuel prices are expected to lift transportation costs, and then food prices, in the short term, which could increase the difficulty of controlling inflation, according to Yu.

However, it is unlikely that global commodity prices will continue rising, because demand may remain low in the coming months, he added.

In February, the consumer price index, a main gauge of inflation, dropped to a 20-month low of 3.2 percent from 4.5 percent in the first month of this year.

Last year, CPI surged 5.4 percent, far above the target of 4 percent, mainly because of fast-rising food prices, according to the National Bureau of Statistics.

"Rising labor costs may keep inflation at a relatively high level in the long term, and a CPI between 4 and 5 percent is acceptable for China's economy," Yu said.

Pressure for the authorities to loosen monetary policy is building, while loan demand has been weak in the first quarter, according to Zhang Zhiwei, chief economist in China with Nomura Securities.

"We expect more loosening to come if headline growth numbers, such as industrial production and fixed-asset investment, drop further in March," Zhang said.

He said that cutting interest rates may be also necessary to boost loan demand, in addition to reducing commercial banks' reserve ratios.

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