BEIJING Activity in China's factory sector edged up to a seven-month high in February but export orders shrank and deflationary pressures persisted, a private business survey showed, adding to the view that yet more interest rate cuts will be needed.
Chinese policymakers are embarking on their biggest easing campaign since the depths of the global crisis as the world's second-largest economy is weighed down by a cooling property market, high debt levels and excess factory capacity.
The People's Bank of China cut interest rates on Saturday, in the latest effort to support the economy as its momentum slows. The move was its third major policy easing since late November and came just days before the annual meeting of the country's parliament.
On Monday, a survey showed the HSBC/Markit Purchasing Managers' Index (PMI) climbed to 50.7 in February - the strongest level since July - from 49.7 in January, as overall new orders picked up.
The number was stronger than a preliminary reading of 50.1, which was just above the 50-point level that separates growth in activity from a contraction on a monthly basis.
But even as factory activity picked up slightly, the survey showed manufacturers struggled to cope with erratic export demand and deflationary pressures.
The new export orders sub-index dipped to 48.5 in February, the sharpest contraction in a year, while both input and output prices fell for a seventh month. Manufacturing employment shrank for a 16th month, although the pace of job shedding moderated.
"China's manufacturing sector saw an improvement in overall operating conditions in February, with companies registering the strongest expansion of output since last summer while total new business also rose at a faster rate," said Annabel Fiddes, an economist at Markit.
"However, the renewed fall in new export orders suggests that foreign demand has weakened, while manufacturers continued to cut their staff numbers (albeit fractionally)."
An official survey released on Sunday showed China's factory sector contracted for a second straight month in February on unsteady exports and slowing investment, reinforcing bets that more policy loosening is needed.
The official survey looks more at larger, state-owned firms, while the HSBC/Market survey focuses on smaller firms.
MORE POLICY EASING
"We cannot see any signs of stabilization in the economy. We expect more policy easing via interest rate and reserve requirement cuts," said Zhou Hao, an economist at ANZ.
Chinese authorities will lean on interest rate and reserve requirement cuts and tolerate some currency weakness to ensure the economy grows around 7 percent this year, as they try to head off deflation and keep employment strong enough to push on with reforms, policy insiders have said.
The economy grew 7.4 percent in 2014, its slowest expansion in 24 years. Growth may slow 7 percent in the first quarter - widely seen as the minimum level for keeping employment steady - from 7.3 percent in the fourth quarter, a top government think tank said in a research report.
China's reform-minded leaders have shown greater tolerance for slower growth, but will have to avoid a sharper slowdown that could fuel job losses and debt default risks, analysts say.
China's yuan CNY=CFXS fell to its weakest level since October 2012 against the dollar on Monday after the rate cut.
The PBOC unexpectedly cut interest rates in November - for the first time since 2012 - and then followed up with a cut to banks' required reserve ratio in early February.
Despite the raft of stimulus moves, a newspaper owned by the central bank warned on Wednesday that China is dangerously close to slipping into deflation, highlighting the nervousness among policymakers about the sputtering economy.
Annual consumer inflation hit a five-year low in January while factory deflation worsened. Export and import growth had also tanked in the same month, performing worse than expected.
(Reporting by Kevin Yao; Editing by Kim Coghill)