BEIJING (Reuters) - China's factory activity shrank more than initially estimated in July, contracting by the most in two years as new orders fell and dashing hopes that the world's second-largest economy may be steadying, a private survey showed on Monday.
The report followed a downbeat official survey on Saturday which showed growth at manufacturing firms unexpectedly stalled, reinforcing views that the cooling economy needs more stimulus even as it faces fresh risks from a stock market slump.
Fears of a full-blown market crash have added a new sense of urgency for policymakers in Beijing, with many analysts expecting more support measures to be rolled out within weeks.
The final, private Caixin/Markit China Manufacturing Purchasing Managers' Index (PMI) dropped to 47.8 in July, the lowest since July 2013, from 49.4 in June.
That was worse than a preliminary "flash" reading of 48.2 and marked the fifth straight month of contraction, as indicated by a reading below 50.
New orders reversed into contraction last month after growing in June, while factory output shrank for the third consecutive month to hit a trough of 47.1, a level not seen in more than 3-1/2 years.
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The survey showed deteriorating business conditions forced companies to cut staffing levels for the 21st straight month. Factories also had to reduce selling prices to a six-month low due to increasing competition, squeezing profit margins.
"We believe the stock market panic in early July chilled economic activity, which is what the manufacturing PMIs picked up," ING economist Tim Condon said in a research note ahead of the Caixin PMI release.
But Condon said the factory weakness may be transitory if unprecedented stock market support measures from Beijing in recent weeks succeed in halting panic selling.
The official factory Purchasing Managers' Index (PMI) at the weekend was also weaker than expected, falling to 50.0 in July from June's sluggish growth reading of 50.2. The official survey focuses more on larger companies.
While growth in the services sector picked up slightly, offsetting some of the drag from persistent factory weakness, services companies reported new orders were cooling and said they were cutting jobs at a faster pace.
China Glass Holdings Ltd on Friday became the latest in a growing list of firms issuing profit warnings due to weakening demand, saying it expected to post a first-half loss.
China's slowdown is also forcing many Western companies to take a hard look at their businesses there, leading many to reduce investments, costs and product lines and to tackle increasing bad debts.
"We had five fabulous years in China, of course, where we grew strong double-digit, and it has been gradually slowing down. Currently, in China we had negative order intake," Frans van Houten, chief executive of Dutch electronics group Philips NV, told analysts last week.
"Going forward, we need to be much more modest on expectations with regard to China growth; that's just being realistic," he said.
Chinese shares<.CSI300) extended early losses on Monday after the activity surveys, while the Australian dollar dipped on fears of weaker China demand for commodities.
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The People's Bank of China (PBOC) has already cut interest rates four times since November and repeatedly loosened restrictions on bank lending in its most aggressive stimulus campaign since the global financial crisis.
Beijing has also intervened heavily in recent weeks to try to stabilise tumbling stock markets, which has raised questions over its commitment to free-market reforms, seen as essential for its planned transition from an export-led economy to one based on consumption and services.
While there is little evidence yet that the 30-percent stock market slump since mid-June has hit spending, analysts say wild price swings will rattle consumer and business confidence and could dampen activity in the financial services sector if Beijing can't keep investors from fleeing the market.
Buffeted by softening investment growth, unsteady domestic and foreign demand and a cooling housing market, China's growth is widely expected to grind to its lowest in a quarter of a century this year at 7 percent, from 7.4 percent in 2014.
After months of weakness, industrial output, retail sales and investment all grew slightly more than expected in June, raising hopes that earlier policy easing measures were finally starting to take effect.
In an acknowledgement of the difficulties that lay ahead, China's Politburo, the decision-making body of the Communist Party, promised last week to step up policy adjustments to keep growth stable.
If the stock market steadies, ING's Condon said Beijing will still need a continued turnaround in its housing market to hit its 7 percent growth target for this year.
However, while home sales and prices are showing signs of improving slowly in bigger cities after a year-long slump, a massive overhang of unsold homes could keep real estate under pressure well into next year, deterring developers from starting new construction.
(Reporting by Beijing Newsroom and Koh Gui Qing; Editing by Kim Coghill)