China's factories steadying but weak, hopes for quick recovery fade

By Elias Glenn

BEIJING (Reuters) - China's manufacturing activity showed signs of steadying in May but remained weak amid soft demand at home and abroad, suggesting the world's second-largest economy is still struggling to regain traction.

A rebound in March had raised hopes that China's economy was reviving, breathing life into global financial and commodity markets, but analysts said the soggy activity readings and weak April data suggest no quick recovery is in sight.

China's official factory activity gauge expanded for the third straight month in May, but only marginally, while a private survey showed conditions deteriorated for a 15th straight month. Both showed factories continued to cut staff.

"The question was whether the March rebound was a one-month story, or whether weakening in April was the outlier. Our expectation is May and June will fall somewhere in-between." said Zhu Haibin, chief China economist at JPMorgan.

"The real estate market recovery has maintained momentum, the number of new investment projects is strong, and corporate earnings have also improved. The modest recovery will continue."

The May Purchasing Managers' Index (PMI) was unchanged from April at 50.1, barely above the neutral 50-mark.

To be sure, higher commodity prices, a better housing market and plenty of government spending have helped the industrial sector, but questions remain as to whether the upturn will last.

Chinese steel prices posted their sharpest monthly drop on record in May, while more cities are tightening mortgage requirements, fearing house prices are growing overheated.

"Prices are recovering and inventories are falling. The economy is improving, but we aren't sure it is sustainable. We think the data may decline again starting in July or August," said economist Wang Jianhui at Capital Securities in Beijing.

The official output index edged up to 52.3, indicating production remains solid despite government pledges to curb overcapacity plaguing sectors such as steel. But new orders expanded more slowly, while growth in export orders stalled.

A private factory survey painted a darker picture. Faced with shrinking demand, smaller manufacturers continued to cut payrolls at a rate similar to February's multi-year record.

The private Caixin/Markit Manufacturing Purchasing Managers' index (PMI) fell to 49.2 last month, below market expectations of 49.3 and April's reading of 49.4.

POLICY RESPONSE

With the economy not yet on firm footing, economists expect Beijing to keep up its infrastructure building spree but are dialling back expectations for further broad policy easing by the central bank, which has cut interest rates and banks' reserve requirements repeatedly since late 2014.

Investors have been buzzing over whether China is shifting to a more cautious policy stance since a People's Daily article in May that warned about the dangers of relying on too much debt to stimulate the economy.

"The room for stimulus is very limited. The government needs to control the risk of rising debt. The government may continue with short-term liquidity injections, but will not stimulate the economy with a big increase in new loans," said Wang.

"Today's figure rule out the possibility of imminent broad-based monetary policy easing", ANZ analysts said in a note.

A record first-quarter credit binge boosted investment and industrial output in March, but banks sharply cut April lending.

SERVICE SECTOR SHOWING SIGNS OF FATIGUE?

A similar survey showed activity in China's services sector continued to expand but at a slower pace, with the official reading dipping to 53.1 from 53.5 in April. Growth was weighed down by a slowing financial services sector.

"Last year we saw strong second-quarter growth in financial services. Growth will be in the single digits for financial services this year," said JPMorgan's Zhu.

Beijing has been counting on a strong services sector to pick up the slack as it shifts the economy away from a dependence on heavy industry and manufacturing exports.

(Reporting by Elias Glenn; Editing by Kim Coghill)