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China services and manufacturing PMIs expanded in August

Factory activity in China expanded at its fastest pace in nearly two years in August, an official survey showed Thursday, although analysts cautioned that the world's second-largest economy wasn't out of the woods yet.

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 official manufacturing Purchasing Managers' Index (PMI), which mainly tracks large state-owned companies, rose to 50.4 last month, the highest reading since October 2014. August's print was well above Reuters estimates for a 49.9 result and beating July's reading of 49.9 and the 50.0 logged in June.

A number above the 50-level indicates growth, while one below 50 suggests contraction.

"The latest manufacturing PMI reading is encouraging, with caveats. While light manufacturing has improved, heavy manufacturing apparently remains in contraction. Given the latter is slightly larger in industrial output, it mutes the potential upside from the most recent improvement," commented Brian Jackson, China economist at IHS Global Insight.

Another PMI survey focused on small and mid-sized firms by Markit/Caixin came in at 50 last month, slightly missing estimates for 50.1 and below July's 50.6 reading. A third survey meanwhile revealed the official services PMI fell to 53.5 in August, down from 53.9 in July.

Market reaction was mixed following the data. Benchmark equity indices in Shanghai and Hong Kong were modestly lower but the Australian dollar ticked up 0.3 percent against the greenback.

While economists cheered the fact that all three figures were above 50, they warned China-watchers to contain their excitement.

July's number was unusually weak so that helped to explain the pick-up in August, Zhu Haibin, chief China economist and head of Greater China economic research at J.P. Morgan, told CNBC's Squawk Box.

"The big question is where growth momentum on a sequential perspective is going over the next few quarters. There's still a lot of uncertainty," Zhu said.

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Among small and mid-sized manufactures, production and total new orders both rose at slower rates while export sales continued to decline in August, Caixin said in a statement, calling current operating conditions "stagnant."

"We're on the threshold of positive and negative," stated Ronald Wan, chief executive of investment banking at Partners Capital International, adding that a depreciating renminbi and tepid global demand continue to weigh on Chinese factories

Policy implications

As Beijing expresses its wish to abstain from big-bang monetary stimulus this year, the economy's key risk going into the second half of the year was policy complacency, Haibin said.

"It's not necessary to take excessive stimulus to achieve the growth target," People's Bank of China (PBOC) governor Zhou Xiaochuan was quoted as saying in March, according to a Reuters report.

If the government became too comfortable with the economic status quo, it may tighten fiscal and monetary policy, Haibin warned.

While the economy did not need extra stimulus for now, there were plenty of worrisome signs, such as falling private investment and volatile housing policies, he continued.

In a note released ahead of Thursday's data, the Institute of International Finance (IIF) warned that the economy's current tranquil period may not last long.

"Beneath the generally calm surface, the underlying stresses in the economy continue to build, and will eventually need to be faced more squarely in order to forestall a more pronounced deterioration in economic performance," said Charles Collyns, chief economist and managing director.

"Eventually a major policy overhaul will be needed—but this won't happen until late next year, as the second half of the Xi mandate begins, at the earliest."

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