China's factory activity likely fell for a third successive month in January, suggesting Beijing's pro-growth policies will remain in place despite early signs that the downward drift is slowing, a survey of purchasing managers showed on Friday.

The HSBC flash manufacturing purchasing managers index (PMI), the earliest indicator of China's industrial activity, stood at 48.8 in January, a three-month high and a slight improvement on the 48.7 final reading of the December index.

Turnarounds in sub-indexes measuring new export orders, backlogs of work and stocks of finished goods were all signs of strengthening activity, though the overall reading stayed below the 50 level -- which demarcates expansion from contraction -- where it has languished for most of the last seven months.

New orders overall ticked to a three-month high, but failed by a narrow margin to get back above the 50 level.

Areas of concern for investors linger beside the bright spots though, with the overall output index signaling contraction at a faster rate in January than December -- a trend also reflected in the stocks and quantities of purchases.

The most vulnerable firms are the all-important, highly externalized ones in the manufacturing sector -- especially the smaller firms, which the HSBC flash is weighted towards, Jeremy Stevens, China economist with Standard Bank in Beijing said.

These smaller firms have long tentacles reaching deeply into the broader economy. The data confirms that many have been forced into lock-down mode, favoring cash preservation over revenue generation, he wrote in a note to clients.

Deteriorating demand from China's biggest trading partners in the European Union and the United States helped drag growth in the world's second-biggest economy down to its lowest in 2-1/2 years in the final quarter of 2011.

The new export orders sub-index, however, managed to bounce to 51.1 from a three-month low.

That followed a run of recent official data that showed a surprising uptick in industrial output growth to 12.8 percent in December 2011 from a year ago and a year-on-year 18.1 percent jump in retail sales.

But official data has also shown a fall in fixed asset investment growth and a further slowdown in the rate of property investment that has been a key driver of economic expansion.

Elsewhere in Asia, Japanese manufacturers remained pessimistic about business conditions for the second straight month in January amid Europe's debt crisis and the slowing global outlook, a Reuters poll showed on Friday.

But manufacturing sentiment is seen bottoming out over the next three months, according to the poll.


The PMI survey did nothing to turn Qu Hongbin, chief China economist at HSBC, from the view that more fine-tuning of economic policy should be expected from the Chinese government.

The third consecutive below-50 reading of the manufacturing PMI suggested that growth is likely to moderate further, he said in a statement accompanying the index.

Despite the upside surprise of industrial production growth in December, the ongoing slowdown of investment and exports implies more headwinds to growth and likely destocking pressures for manufacturers in the coming months. We expect more policy easing to stabilize growth, Qu said.

Economists forecast a fifth-successive quarter of slower Chinese GDP growth in the first three months of 2012, easing further from the 8.9 percent of Q4 2011. Many expect the year ahead to deliver the slowest overall growth in a decade.

The pullback in activity has fuelled expectations that the government will take more forceful measures to bolster growth and save jobs, beyond the so-called fine-tuning it began to implement in October, in the face of a festering European debt crisis and a sharp slowdown in the domestic property sector.

Beijing reduced the amount of cash that banks have to hold as reserves in November for the first time in three years in a bid to shore up cooling economic activity and maintain a steady supply of credit to companies and consumers.

That 50 basis point cut to 21 percent is forecast by economists to be followed by up to 200 bps more throughout the course of 2012, a Reuters poll showed on Thursday.

The January readings from the HSBC flash PMI -- based on up to 90 percent of total responses to a monthly survey -- are likely to have been muddied by the Lunar New Year holidays, which occur earlier than usual in 2012.

(Reporting by Nick Edwards; Editing by Ken Wills)