China's manufacturing activity expanded in January at its fastest pace in two years, HSBC said Thursday, the latest sign of recovery in the world's second biggest economy.

The British banking giant's preliminary purchasing managers' index (PMI) reached 51.9 for this month, up from a final 51.5 in December. The January figure is the highest for 24 months.

The index, compiled by information services provider Markit and released by HSBC, tracks manufacturing activity and is a closely watched barometer of the health of the economy.

A reading above 50 indicates expansion and it only returned to positive territory in November after 12 consecutive months of contraction.

Qu Hongbin, a Hong Kong-based economist with HSBC, said improving domestic demand had encouraged Chinese manufacturers to increase production, although foreign markets remained sluggish.

"Thanks to the continuous gains in new business, manufacturers accelerated production by additional hiring and more purchases," he said.

"Despite the still tepid external demand, the domestic-driven re-stocking process is likely to add steam to China's ongoing recovery in the coming months."

China's economy expanded 7.8 percent last year in the face of weakness at home and in key overseas markets, its lowest annual figure since 1999.

But it grew 7.9 percent in the final three months of 2012 from a year earlier as industrial output and retail sales strengthened, snapping seven straight quarters of slowing growth.

The People's Bank of China, the country's central bank, last cut interest rates in July last year, and has instead used open market operations to boost liquidity to support the economy.

Last week, the central bank said it would start carrying out short-term operations to manage liquidity in the money market, which analysts say will give policy-makers more flexibility.

Zhang Zhiwei, Nomura International's China economist in Hong Kong, said the strong PMI reading in January reinforced expectations that economic growth in the first quarter would further gain momentum.

But with inflation rising and spurring growth a less urgent concern, policies are likely to gradually turn tight, he added.

"The government will be more concerned on inflation and its policies will be more careful to control risks, leading year-on-year credit growth to slow down," he told AFP.

"Therefore economic growth in the second half of the year is likely to slow as well."

China's consumer price index (CPI), a main gauge of inflation, rose 2.6 percent in 2012, official data showed, down from 5.4 percent the year before.

But price rises picked up towards the end of last year to hit 2.5 percent year-on-year in December, the highest since May's 3.0 percent.