Chinese bonds will drop further should the central bank raise interest rates and cut taxes on deposit income, according to China Galaxy Securities Co.

The government may seek to make bank accounts more attractive after inflation prompted households to seek higher returns in stocks and property. The National People's Congress approved a cut in the 20 percent tax last month, without setting a date.

"Bonds may fall further because it seems likely that the deposit interest tax will be cut by half," said Feng Chen, a Beijing-based fixed-income analyst at Galaxy, the nation's biggest securities brokerage by assets. "The bond price has included the forecast of a hike of about 27 basis points."

A government report yesterday showed the economy expanded 11.9 percent in the second quarter from a year earlier, the fastest in 12 years, reinforcing speculation that the People's Bank of China will raise rates for a third time this year. The consumer price index climbed 4.4 percent in June, higher than China's one-year deposit rate of 3.06 percent.

The yield on three-year bonds rose 0.4 basis point to 3.45 percent, according to the China Interbank Market. The debt's yield has risen 1 percentage point so far this year. The 2.66 percent security due February declined 0.005, or 0.05 yuan per 1,000 yuan face amount, to 98.08. One basis point is 0.01 percentage point.

The bond market has slumped 2.6 percent this year, the worst performer among 10 local-currency debt markets tracked by HSBC Holdings Plc. It declined as the central bank raised interest rates twice and increased the reserve requirement of banks five times to mop up excess money in the economy.