(Reuters) - China's factory activity expanded at its fastest pace in 18 months in July as new orders surged, a preliminary HSBC survey showed on Thursday, the latest indication that the economy is picking up as government stimulus measures kick in.
The HSBC/Markit Flash China Manufacturing Purchasing Managers' Index rose to 52 in July from June's final reading of 50.7, beating a forecast of 51 in a Reuters poll.
It was the highest reading since January 2013, and above the 50-point level that separates growth in activity from contraction for the second consecutive month.
"Economic activity continues to improve in July, suggesting that the cumulative impact of mini-stimulus measures introduced earlier is still filtering through," said Qu Hongbin, chief economist for China at HSBC.
"We expect policy makers to maintain their accommodative stance over the next few months to consolidate the recovery."
Mainland China stocks jumped after the PMI report while shares in the rest of Asia edged higher. The Australian dollar hit a three-week high on prospects of stronger exports to China.
Still, some analysts say the recovery appears patchy, and more stimulus may be needed to offset the downdraft from the cooling property market on the broader economy and increasing risks in the financial system, such as deteriorating credit quality.
The official Financial News reported on Thursday that the amount of bad bank loans in China's eastern Shandong province surged nearly 26 percent in the first half of the year due to slower economic growth and government efforts to deal with industries which have large amounts of excess capacity.
"The economy is showing initial signs of a recovery. There is no reason the government will stop taking action," said Shen Jianguang, an economist at Mizuho in Hong Kong.
"We believe favorable fiscal and monetary policy need to be expanded further."
China's cabinet pledged on Wednesday to boost its support for small companies and the farming sector by getting commercial banks and the central bank to disburse more loans to them.
A breakdown of the factory activity numbers showed most of 11 sub-indices that measure output, domestic and foreign demand improved substantially from June, underlining improving performance for the smaller manufacturers tracked by the HSBC/Markit survey.
"With the effects of government measures gradually filtering through and more positive factors coming up, we expect the industry sector to maintain steady growth in the second half and the growth momentum to strengthen further," Zheng Lixin, a spokesman for the Ministry of Industry and Information Technology, told a news conference on Thursday.
Since April, China has steadily loosened policy by reducing the amount of cash that some banks have to hold as reserves, instructing regional governments to quicken their spending, and hastening the construction of railways and public housing.
A sub-index measuring new orders, a gauge of demand at home and abroad, hit a 18-month high of 53.7, while the sub-index for output also rose to a 16-month high in June.
The employment index also improved from May, though it was still a shade under 50, which implies that jobs are still being lost in the manufacturing sector.
Any marked weakening in the labor market would raise alarm bells for China's government, which regards healthy employment levels as a top policy priority and an important condition for social stability.
Premier Li Keqiang said last week that economic growth of slightly more or less than 7.5 percent this year would be acceptable as long it still led to new jobs and higher wages.
However, the industry ministry also noted Thursday that the economy still faces downward pressures as some firms struggle with operating difficulties.
A troubled Chinese construction company avoided a landmark bond default at the last minute on Wednesday after it raised enough funds.
The move let Huatong Road & Bridge Group Co Ltd steer away from what would have been the first public default in China's massive interbank bond market - where 94 percent of all Chinese bonds are issued.
China's economy grew slightly faster than expected in the second quarter, expanding by 7.5 percent, as the burst of official stimulus paid dividends, but some analysts say the recovery appears largely dependent on government assistance.