The bank also downplayed concerns over a "wage-inflation spiral" in China after Beijing launched a round of minimum wage hikes and several foreign-backed factories raised salaries in response to labour unrest.

"The gains from letting interest rates play a larger role in monetary policy are likely higher than the costs," the World Bank said in its latest quarterly update on the world's third-largest economy.

Interest rates in China were significantly lower than expected rates of return on "property and physical investment", fuelling over-investment and real estate speculation, it said.

Official concerns that higher interest rates would attract massive capital inflows seemed "overdone", it added.

Beijing has delayed raising interest rates partly due to concerns it could attract speculative money chasing a relatively higher yield, complicating its efforts to keep the Chinese yuan stable.

Instead, authorities have preferred more targeted measures to curb torrid bank lending, which reached 9.6 trillion yuan (1.4 trillion dollars) in 2009, and runaway real estate prices to thwart inflationary pressures and economic overheating.

However, Wang Qing, a Morgan Stanley economist based in Hong Kong, said an interest rate hike looked unlikely this year as signs of economic overheating have ebbed.

"Currently economic activities are slowing down and the inflation index has hit a peak level and is easing. So there is no need for interest rate hikes," he told AFP.

The World Bank, which provides financial and technical aid to developing nations, also reiterated its view that a stronger currency would help contain inflationary pressures and rebalance the economy.

China has effectively pegged the yuan at about 6.8 to the dollar since mid-2008, which critics say gives its exporters an unfair trade advantage.

While core inflation remained low, the bank said major risks to the Chinese economy were rising asset prices, financial strains on local governments that have borrowed heavily to fund infrastructure and other projects, and bad debts.

The recent wave of wage hikes around the country -- by the government and factories responding to labour disputes -- were "part of a cyclical issue" and were "within historical norms", the bank said.

"Given the flexibility of China's labour market and the track record of China's overall manufacturing sector in absorbing wage increases ... this is unlikely to set in motion an unwarranted wage-inflation spiral," it said.

After expanding 11.9 percent in the first quarter, the bank said it expected the Chinese economy to grow at a slower pace over the rest of 2010.

The bank maintained its forecast for China's gross domestic product to surge 9.5 percent this year, much higher than the government's own target for 2010 of around 8.0 percent and the 2009 growth rate of 8.7 percent.

A slowdown in government-backed spending this year would be partly offset by strong real estate investment and robust household consumption, it said.

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