Manufacturing activity in China contracted for the first time in a year in July to hit a 28-month low, early HSBC data showed Thursday, the latest sign monetary tightening measures are being felt.
However, the figures also indicated that despite several interest rate hikes aimed at tempering stubbornly high inflation the cost of raw materials continued to rise.
HSBC's preliminary purchasing managers index fell to 48.9 in July from a final reading of 50.1 in June, the British banking giant said.
A reading above 50 indicates the sector is expanding, while a reading below 50 indicates contraction.
The July reading, which is subject to revision when the bank publishes its final figures on August 1, was the lowest since March 2009 and fell below 50 for the first time since July 2010.
"We expect industrial growth to decelerate in the coming months as tightening measures continue to filter through," HSBC chief economist Qu Hongbin said in a statement.
Qu said the world's second-largest economy is still likely to grow nearly nine percent in the rest of the year, supported by resilient consumer spending and continued massive investment in infrastructure projects.
The contraction in July may be partly due to seasonal factors such as a regular decline in orders during the summer months as foreign customers go on holiday, Yao Wei, a Hong Kong-based economist with Societe Generale, told AFP.
It also showed that many small and medium-sized firms, which the HSBC survey focuses on, had been hit hard by tighter credit conditions as Beijing stepped up measures to curb bank lending, she said.
But what will likely worry policymakers is data showing input prices, including costs of raw materials and fuels, rose at a faster rate in July than the previous month, indicating manufacturers remain under significant inflationary pressure.
Chinese officials have been pulling on a variety of levers to prevent the economy from overheating and rein in inflation -- which hit a three-year high of 6.4 percent in June -- amid fears high prices could trigger social unrest.
In a bid to stop money flooding the system Beijing has increased the amount banks must hold in reserve several times -- which cut lending 10 percent in the first half of 2011 -- while interest rates have risen five times since October.
Economic growth slowed to 9.5 percent in the second quarter from 9.7 percent in the first three months of the year and 9.8 percent in the fourth quarter of 2010.
Manufacturing accounts for nearly 50 percent of China's economy so a contraction in the sector will impact overall growth, Yao said.
But authorities were unlikely to scrap tightening measures as the slowdown, was tolerable so far, she added.