* HSBC PMI rises for 3rd time in row to 49.8 in Sept
* Output grows as factories clear order backlog
* Employment drops, but at weaker pace than in prior months
By Silvio Cascione
SAO PAULO, Oct 1 Brazil's manufacturing sector nearly broke out of its downturn in September, recording its best month since March on strong output and a slower pace of layoffs, a private survey showed on Monday.
At 49.8 in September, the HSBC Purchasing Managers' Index for the Brazilian manufacturing sector was still short of the 50 mark that divides contraction and expansion. However, it was the third straight month the number has moved higher, suggesting the downturn in manufacturing activity is becoming less pronounced.
The HSBC PMI survey is comprised of 11 components. One of them, manufacturing output, showed production expanded in September as factories shrugged off weak demand to focus on launching new products.
That suggested business confidence is growing after more than a year of aggressive stimulus measures by President Dilma Rousseff's government.
"The PMI survey reinforces perceptions that Brazil's manufacturing sector experienced a modest rebound at the end of the third quarter and supports the improvement of sentiment regarding the economic outlook for the fourth quarter of 2012," said Andre Loes, HSBC's chief economist for Brazil.
Another survey released last week by the Getulio Vargas Foundation, a local think tank, revealed confidence among Brazilian industrialists jumped in September to its highest level since July 2011.
On top of plans to launch new products, factories boosted output by depleting their order backlogs, said Markit Economics, who compiled the data for HSBC.
Brazilian factories have been hit hard by the current global slowdown, which has reduced demand for goods. Official data released on Monday showed that Brazil's trade surplus narrowed for the sixth straight month in September as exports continued to struggle.
Saddled with onerous taxes, a strong currency and a dwindling pool of skilled labor, Brazilian manufacturers have found it difficult to compete with lower-cost producers elsewhere.
But some recent indicators suggest that a tentative recovery is underway.
Brazil's industrial output rose in July for the second straight month, surpassing market expectations, according to government data. Brazil's statistics agency IBGE will release industrial data for August on Tuesday.
Automobile output jumped 10.6 percent in August versus July, according to the national carmakers' association Anfavea.
To support the recovery, the central bank has cut its benchmark interest rate to a record low of 7.5 percent -- a far cry from over 26 percent just nine years ago. Rousseff has also offered a string of tax breaks and credit incentives to help revive Brazil's flagging industry.
"The pick-up in September's manufacturing PMI adds to recent evidence suggesting that policy stimulus is starting to take effect in Brazil," wrote Neil Shearing, chief emerging markets economist at Capital Economics.
"We suspect that the turnaround in the real economy will ultimately be more lackluster than most now expect, but even so it seems likely that the central bank will call an end to monetary easing and keep interest rates on hold this month."
The HSBC survey showed factories cut payroll jobs for the sixth month in a row, reflecting weak demand, but layoffs came at a slower pace than in the prior three months.
Manufacturers' input costs rose, as higher steel and raw material prices pushed inflation to its fastest since June 2011.
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UPDATE 3-Japan Sept consumer prices fall, weak spending clouds outlook
* BOJ likely to cut price f'casts, stand pat on policy (Adds BOJ's price index)