China's official, unofficial July PMI surveys diverge

Citi on China: Fundamentals are worrisome
Citi on China: Fundamentals are worrisome
China official PMI is not negative: UBS
China official PMI is not negative: UBS
This analyst doesn't believe in China's PMIs
This analyst doesn't believe in China's PMIs

China's manufacturing sector painted a mixed picture in July, with the official activity gauge unexpectedly slipping into contraction territory while an unofficial survey pointed to an expansion for the first time in 17 months.

The government's manufacturing Purchasing Managers' Index (PMI), a survey that tracks the health of large and state-owned companies, came in at 49.9 in July, versus the 50.0 logged in June.

The July official PMI was slightly under forecasts; a poll of analysts by Reuters had predicted a 50.0 reading.

From March to May, the survey logged results above the key 50 level that separates expansion from contraction. In the seven months before March, the survey had remained stuck below 50.

Separately, Caixin's China July manufacturing PMI, which tracks smaller-scale private firms compared to the official gauge, rose above the key 50 level for the first time since February 2015. The index reported a 50.6 reading for July, compared with 48.6 in June.

The divergence between the two PMI readings reflected flooding in parts of China that affected near-term domestic production of large enterprises, while an upturn in the tech cycle helped export-oriented private sector enterprises, JP Morgan economists wrote in a note.

China's economy, the world's second-largest, has shown signs of stabilizing after a torrid summer last year that saw a hefty devaluation in the yuan and an acceleration of capital outflows.

"Driving the headline index higher in July was a renewed rise in total new business. Though moderate, it was the first time that overall new orders had increased since March," Caixin said in its PMI report.

The data however indicated that growth in new business was largely due to stronger domestic demand as export sales declined marginally at the start of the third quarter, the report added.

Workers operate machinery on the assembly line at a Lyric Robert factory, operated by Guangdong Li Yuanheng Intelligent Automation Co., in Huizhou, Guangdong province, China, on Monday, April 18, 2016.
Qilai Shen | Bloomberg | Getty Images

The latest numbers are likely to trigger a debate on whether more monetary support can be expected from the People's Bank of China (PBOC).

Citi's chief China economist Liu Li Gang told CNBC's "Squawk Box" that the Chinese central bank was likely to cut the reserve ratio requirement (RRR), which is the amount of cash banks are required to hold.

This was because second-quarter capital outflow was still substantial, Liu said, and an RRR cut would inject permanent liquidity into the economy. The house had a 49.8 forecast for China's official PMI figure.

"(Caixin's) sub-indexes of output, new orders and inventory all surged past the neutral 50-point level that separates growth from decline. This indicates that the Chinese economy has begun to show signs of stabilizing due to the gradual implementation of proactive fiscal policy," said Zhengsheng Zhong, director of macroeconomic analysis at CEBM Group, a Caixin Insight Group subsidiary.

"But the pressure on economic growth remains, and supportive fiscal and monetary policies must be continued," Zhong said.

China's economy logged a 6.7 percent expansion on-year in the three months through June.

"Even though we had quite steady second quarter growth, underlying economic fundamentals cannot mask very sluggish growth in the second half," Citi's Liu said.

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