China's factory sector is likely to slow slightly for a second consecutive month in August as sluggish overseas demand saps new orders, HSBC's China Flash PMI showed on Tuesday.

The listless performance attests to China's gently slowing economy, and does little to dispel market worries that global demand is faltering on Europe's persistent debt problems and sluggish U.S. growth.

The flash Purchasing Managers' Index (PMI), designed to preview China's factory output before official data is released, edged up to 49.8 in August, from July's final reading of 49.3.

But that still left the index a touch below the 50-point mark that demarcates expansion from contraction in activity. HSBC publishes its final China PMI index for August on Sept 1.

Stock markets rose in China and in big commodity supplier Australia on relief that the report did not show an even sharper slowdown. There had been some market speculation that the reading could be considerably weaker.

Chinese Vice Commerce Minister Jiang Yaoping said on Tuesday debt crises in developed countries were bringing rising pressure and challenges to the vast emerging market countries, including China.

But investors may take heart that despite a mild slowdown in the pace of growth, all data suggests the world's second-largest economy is still expanding robustly. Exports hit record levels in July as factory output grew 14 percent from a year ago.

We maintain our forecast of a soft landing in growth, said Ting Lu, an economist at Bank of America-Merrill Lynch. He expects China's economic growth to ease to around 9 percent in the second half of 2011, from 9.6 percent in the first half.

We believe this HSBC PMI...presents a distorted picture when growth slows, Lu said, citing the survey's brief history, its heavy emphasis on exporters, and its smaller sample size compared to an official PMI survey.

 

FAR FROM COLLAPSING

China's industry sector, which includes manufacturing and resource exploration, accounts for about 40 percent of the country's gross domestic product.

In November 2008, during the throes of the global financial crisis, China's industrial production growth slowed to 5.4 percent, dragging annual GDP growth down to 6.8 percent in the fourth quarter of 2008.

The vast Chinese factory sector is far from testing that trough right now.

Indeed, HSBC believes a PMI reading of as low as 48 in China still points to annual growth of 12-13 percent in industrial output and a 9 percent expansion in GDP, even if it indicates a contraction in factory activity on the month.

On a quarterly basis, Ken Peng, a senior economist at BNP Paribas, said China's GDP is forecast to ease to 2 percent in the July-to-September period, from 2.2 percent in the second quarter.

Risks of a hard landing are still remote, said Qu Hongbin, an economist at HSBC. This provides leeway for the People's Bank of China to keep the current tightening measures in place.

Focusing on the bright side, Qu noted that even though the new export orders sub-index was hovering below 50, it had rebounded to a three-month high of 49.6.

Other sub-indices that missed the 50-point mark include those for output, new orders, stocks of purchases and employment.

Price pressures, on the other hand, did not ease. Factory inflation was little changed, while the output price sub-index rose further above the 50-point level.

Stubborn price pressures would increasingly leave China's central bank in a bind.

Worried that rising prices may stoke social unrest, Beijing is keen to tamp down inflation with prudent monetary policy. Yet, a spluttering world economy argues for it to shift its policy stance to supporting growth from controlling prices.

Despite 10 months of steady policy tightening by Beijing, China's inflation quickened to a three-year high of 6.5 percent in July.

The flash PMI, compiled by British research firm Markit, is based on up to 90 percent of total responses to a monthly survey and is designed to be a snapshot of HSBC's final PMI, which is normally released on the first of the month.

This is the seventh month that HSBC has published a flash PMI for China. In July, the flash reading was 48.9, compared with the final reading of 49.3.