China's factory sector unexpectedly shrinks in January

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China's factory sector unexpectedly shrank for the first time in nearly 2-1/2 years in January and firms see more gloom ahead, an official survey showed, raising expectations that policymakers will take more action to forestall a sharper slowdown.

The official Purchasing Managers' Index (PMI) fell to 49.8 in January, the National Bureau of Statistics said on Sunday, a low last seen in September 2012 and a whisker below the 50-point level that separates growth from contraction on a monthly basis.

The December level was 50.1, and a Reuters poll saw a better result, 50.2 for January. Only one of 11 economists in the poll predicted a January contraction.

Most of the PMI indexes "showed a downward trend, indicating that current economic growth is still in a downtrend," said Zhang Liqun, an economist at the Development Research Centre, a state think-tank.

Some economists said the January reading was especially downbeat as it suggested that factories did not enjoy a usual spike in business before China's annual Spring Festival holiday, which falls in mid-February this year.

The poor January official PMI fueled bets that more monetary policy loosening was in store in the world's second-largest economy.

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"China still needs decent growth to add 100 million new jobs this year, plus China is entering a rapid disinflation process," ANZ economists said in a note to clients.

"We (think) the People's Bank of China will cut the reserve requirement ratio by 50 basis points and cut the deposit rate by 25 basis points in the first quarter," they said.

Marred by a housing slump, erratic growth in exports and a state-led slowdown in investment, China's economy has steadily lost steam in the last year as growth sunk to a 24-year low of 7.4 percent.

Cooling services

And the downturn has also broadened into the country's burgeoning services sector.

A separate official services PMI, also released on Sunday, showed growth in the sector cooled to a one-year low in January.

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The official non-manufacturing PMI fell to 53.7, the lowest level since January 2014, from December's 54.1.

Accounting for 48 percent of China's $10.2 trillion economy last year, the services sector has weathered the growth downturn better than factories, partly because it depends less on foreign demand.

To revive demand, China's central bank unexpectedly cut interest rates in November after unveiling a stream of stimulus measures.

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But despite the steady policy support, analysts polled by Reuters in January still expect economic growth to sag further this year to around 7 percent.

In the January factory PMI, all but one of the sub-indices in the PMI fell from December, indicating entrenched weakness.

Business expectations fell to 48.7, its lowest since records for that began in January 2013, while factory employment dropped to its lowest in nearly a year at 48.1, compared with the previous month's 47.9.

Drop in new export orders

New export orders, a proxy for the trade industry, fell to 48.4, from 49.1 in December.

In line with recent trends, the factory PMI showed the smallest manufacturers which are often privately-owned were the worst hit.

The official PMI looks more at larger, state-owned firms that a private one by HSBC/Markit, but it includes small factories, which in January was 46.4, versus 50.3 for large manufacturers that are mostly government run.

The HSBC/Markit final January PMI will be released on Monday. Its flash reading was 49.8, compared with 49.6 for December.

Underscoring the challenges faced, data last week showed China's factory profits grew at their weakest rate in two years in 2014.

China's industrial ministry said last week that it would aim to grow the manufacturing sector by 8 percent this year, down from last year's actual expansion of 8.3 percent.