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Liu Shijin, a deputy director of the Development Research Center under the State Council, the cabinet, said China's economy would slow to a moderate pace in the coming three to five years, citing challenges from rising labor costs, excess liquidity and difficulty in finding a new source of growth.

China's economy grew 10.3 percent in the second quarter of this year after a rise of 11.9 percent in the first quarter, in what the government described as an expected moderation resulting from targeted structural adjustment.

But Liu sounded an optimistic note on the slowing pace of economic growth.

"Actually, we don't have to be too worried about an economy with moderate expansion," the official Xinhua News Agency quoted him as saying at a forum.

"Because the current economic growth is too high for China."

Liu warned that the easing monetary policy taken by the Federal Reserve would further weigh down the dollar and put pressure on other non-dollar currencies, including the yuan, to appreciate in the future.

Rich economies are introducing a fresh round of quantitative easing, fuelling speculation that rampant liquidity could be channeled to emerging markets.

He added that China's economic stimulus package also injected excessive liquidity into the market, pushing up prices of commodities, equities and other land-related assets or resources.

China's exports and investments would be much better in 2011 than this year, but the growth rate of consumption would pull back slightly from this year's boom, Liu added.

(Reporting by Aileen Wang and Tom Miles)

Bank shares fell sharply on Friday on very high volume, continuing a slide from the previous day. Although recovering some of their losses, Bank of America (BAC.N) shares hit their lowest in over a year, while the KBW bank index .BKX fell 2.4 percent.

Shares of Bank of America, the nation's largest mortgage lender, have fallen 9 percent during the week. Over 595.9 million shares of the company's stock traded on Friday, the most since April 2009 and over four times the 50-day moving average.

Investors worry banks did not follow proper due diligence when foreclosing on homes whose owners were not making mortgage payments, which could result in costly litigation, fines and additional mortgage repurchases.

Kevin Caron, market strategist at Stifel, Nicolaus & Co in Florham Park, New Jersey, said that situation could also weigh on the housing market if the uncertainty discouraged buyers from entering into contracts on properties under foreclosure.

"That speculative investor on the margin may choose to not to engage in that activity, which means there's the potential that you could have some weakness in demand, particularly in the lower-end speculative range of the housing market," he said.

BANK EXECS ON FIRING LINE

Investors will pepper bank executives with questions when those companies present earnings reports next week. Banks reporting results include Wells Fargo (WFC.N), Bank of America, and Citigroup Inc(C.N), three of the largest mortgage lenders in the nation.

The broad S&P financial sector is expected to show earnings of $27.7 billion in the third quarter, a 71 percent increase over a year earlier, although third-quarter revenue growth is seen falling 6 percent to $252.9 billion.

However, earnings estimates have been cut on some banks. Financials with the biggest reductions in earnings estimates for the quarter in the latest week are Goldman Sachs (GS.N), PNC Financial (PNC.N), and Citigroup, according to John Butters, director of U.S. earnings at Thomson Reuters.

The financial sector has been a conundrum in the latest market rally since the start of September. The KBW index .BKX has gained only 4 percent at a time when the broader S&P 500 has rallied nearly 12 percent.

David Giroux, who runs T. Rowe Price's $9.4 billion Capital

Appreciation Fund, said expectations that deflation would weigh on bank earnings in the near term was pressuring the sector. He said banks were now attractively valued and the sector is the fund's largest, making up nearly 15 percent of assets.

"Most of the large banks are asset sensitive, which means that as rates rise, their profits should rise," he said. "So if you're a big believer in deflation, which the market has become a big believer in ... financials do poorly."

Giroux said a second round of stimulus from the Federal Reserve was unnecessary as inflation was already present in the system. Hopes the Fed will pump billions into the economy has helped drive stocks higher recently.

The Treasury Department said on Friday the deficit came to 8.94 percent of gross domestic product for the year ended September 30, versus 10 percent in fiscal 2009.

The government called the deficit-to-GDP improvement the biggest since fiscal 1987.

Nonetheless, the budget gap was still the second-highest in U.S. history and too big to ease market demands and congressional calls for budget restraint in Washington.

"It's still abnormally large in terms of GDP, and doesn't change the need for fiscal consolidation," said Alan Ruskin, global head of foreign exchange market strategy at Deutsche Bank in New York. "You would have to see figures in the 6 percent range before you start to change perceptions that there's been a genuine improvement."

High deficits have become a hot-button campaign issue in November's congressional elections, with many Republicans branding President Barack Obama's spending policies as "reckless." Democrats counter that bailout and stimulus spending was necessary to prevent the economy from collapse and an even worse fiscal picture.

"Congress created this problem, and Congress needs to fix it by cutting spending to balance the budget. Washington's addiction to spending is no excuse to raise taxes," said Rep. Tom Price of Georgia, who heads a group of conservative House Republicans:

DEFICIT SMALLER THAN FORECAST

The budget gap was $177 billion less than the Obama administration had estimated in July, with much of the reduction due to lower-than-forecast spending on financial bailout programs and higher-than-expected tax collections.

"By carefully managing the emergency initiatives to stop the financial panic and by accelerating our exit from those investments, we have significantly lowered the cost to taxpayers, bringing the costs of the financial rescue down by more than $240 billion this year," Treasury Secretary Timothy Geithner said in a statement.

"However, we still have a long way to go to repair the damage to the economy and address the long-term deficits caused by the crisis," he added.

Jeffrey Zients, acting director of the Office of Management and Budget, said in statement: "Thanks in large part to the tough decisions this Administration made over the past two years, the economy is recovering and we're spurring economic growth and job creation.

"Because the President believes that we must also work to get back on a fiscally sustainable path," Zients added, "our FY 2012 Budget policy process will continue to enforce the three-year, non-security discretionary spending freeze and continue our efforts to put the nation on firm fiscal footing."

The Congressional Budget Office in August forecast a deficit of $1.07 trillion for fiscal 2011, which started October 1. An Obama administration budget commission is scheduled to make recommendations for deeper cuts when it convenes in December.

Total federal outlays for fiscal 2010 were $3.456 trillion, down $64 billion from a year earlier, while receipts were $2.162 trillion, up $58 billion.