China reduced its holdings of U.S. Treasury debt in May as total foreign holdings of government debt posted a slight increase.

China's holdings fell by $32.5 billion to $867.7 billion, the Treasury reported Friday. Total foreign holdings edged up $5.8 billion to $3.96 trillion.

The drop in China's holdings and the weak showing overall was a surprise. Analysts expected a sizable gain because they thought foreign investors would seek the safety of U.S. Treasury debt, responding to fears over the European debt crisis.

China is the largest foreign holder of Treasury securities. The 3.6 percent drop in China's holdings in May will likely raise concerns that China could shift money away from Treasury securities. That could raise the cost of financing America's soaring budget deficits.

Japan, the world's second-largest holder of Treasury securities, also cut its holdings in May, to $786.7 billion. That's a drop of 1.1 percent from April.

However, the United Kingdom, the third-largest holder, posted a 9 percent increase. Its Treasury holdings rose to $350 billion.

The Treasury reported that net purchases of long-term securities, covering U.S. government debt and the debt of U.S. companies, increased by $35.4 billion in May. That followed bigger gains of $81.5 billion in April and $141.4 billion in March.

Foreign holdings of U.S. debt are closely watched because they can provide signals on the direction of U.S. interest rates. The financial crisis pushed U.S. interest rates down significantly after foreign investors rushed to the safety of U.S. government bonds.

That development helped reduce the costs of financing federal budget deficits, which have soared under the impact of the government's efforts to deal with a severe recession.

The federal deficit hit an all-time high of $1.4 trillion last year and is forecast by private economists to total $1.3 trillion this year.