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Caixin China PMI drops sharply; Asia markets sell off

The preliminary China Caixin purchasing managers index (PMI) surprised markets by dropping to a 15-month low in July, with analysts pinning the hit on the recent stock market crash and weak export demand.

The index, released Friday, fell to 48.2, coming in well below the 49.7 forecast from a Reuters poll and the 50-mark separating growth from contraction.

"The PMI came as a big surprise for the market, which was expecting an increase," Dariusz Kowalczyk, senior economist at Credit Agricole private bank, said. "I believe the reading reflects the negative impact of the stock market crash, the weaker outlook for consumption and the worsening of availability of funding for investment," he said, noting that initial public offerings (IPOs) were suspended in the wake of stock market turmoil.

After the data, the Australian dollar dropped as low as $0.7292 - its lowest against the greenback since May 2009, during the Global Financial Crisis - from $0.7345 before the release. China is among Australia's largest trading partners, offering a market for resources exports.

The Shanghai Composite reversed gains to end down 1.3 percent, breaking a six-session winning streak.

A worker stands on piles of industrial products before exporting, at a port of Lianyungang, China
China Daily | Reuters
A worker stands on piles of industrial products before exporting, at a port of Lianyungang, China

The data mark a sharp contrast to China's quarterly gross domestic product (GDP) data released last week, which beat forecasts by showing 7.0 percent growth, renewing long-standing concerns over data accuracy.

"Recent improvements in economic momentum may have been derailed this month by weaker foreign demand," Julian Evans-Pritchard, a China economist at Capital Economics, said in a note Friday, adding that the export orders component of the data posted the largest decline. "Today's PMI reading suggests that the improvement in momentum seen at the end of the second quarter may not have extended into the start of the third quarter and that downside risks to growth remain."

He doesn't believe the recent stock market turmoil was to blame for the disappointing data, citing a "weak link" between equity prices and consumption on the mainland.

Concerns about slowing economic growth on the mainland have spurred policy makers to action. Late last month the People's Bank of China (PBOC) cut interest rates and the reserve requirement ratio (RRR) for some lenders in a bigger-than-expected easing package. That marked the PBOC's fourth round of major action since November amid concerns that the government's annual GDP target of "around 7 percent" could be at risk. China last cut both interest rates and the RRR at the same time in December 2008, at the peak of the global financial crisis.

Read MoreMarkit's must-read China PMI finds new home

Last month, the mainland's official manufacturing PMI stood at 50.2, unchanged from the previous month and slightly below the 50.3 tipped in a Reuters poll.

Markit's China PMI data tends to focus on smaller and medium-sized companies, filling a niche that isn't covered by the official data.

But Kowalczyk expects the data may improve ahead, with the government still likely to meet its growth target of around 7.0 percent gross domestic product (GDP) growth for the year. "But more infrastructure spending will be needed," with the central bank likely to take more easing steps, he said.

"Now that the equity market is already rising, I would expect that in August, sentiment would improve," he said.

Read More 'Hard won' China Q2 growth prompts new data questions

China's main stock index recently plummeted 30 percent after running up more than 150 percent in about a year. In response, the government imposed a series of restrictions to stem the fall, including a ban on new initial public offerings and a measure preventing large stakeholders from selling their shares.

Capital Economics' Evans-Pritchard also expects some improvement ahead.

"We remain relatively sanguine about the near-term outlook," Evans-Pritchard said. "We think that recent policy easing has yet to fully feed through into stronger economic activity and expect policymakers to respond to signs of weakness by stepping up support in order to prevent growth from slipping much further this year."

The closely watched PMI data prepared by Markit briefly went without a sponsor after HSBC's five-year contract came to an end and wasn't renewed.

While HSBC had sponsored the data for countries across Asia, under the fresh sponsorship deals China was split off from the rest of the region. Chinese media group Caixin, which focuses on business news, now brands the China data, saying it was part of a strategy to increase its financial information offerings.

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1