UPDATE 2-Lunar New Year distortion? China factory growth slows the most in 1-1/2 yrs

1-1/2 yrs@

* Feb official manufacturing PMI 50.3, lowest since July 2016

* Feb official services PMI 54.4, lowest since October 2017 (Adds economists' quote, context and market reaction)

BEIJING, Feb 28 (Reuters) - Growth in China's manufacturing sector in February cooled to the weakest in over 1-1/2 years, raising concerns of a sharper-than-expected slowdown in the world's second biggest economy this year as regulators tighten the screws on financial risks.

The weakness was driven by disruption to business activity due to the Lunar New Year holidays and curbs to factory output from tougher pollution rules, but there are worries of a bigger loss in momentum. "Although a recovery looks possible in the short-run as the anti-pollution campaign winds down, the risk is still that the economy fares worse this year than is generally expected," said Julian Evans-Pritchard, senior China Economist at Capital Economics.

The official Purchasing Managers' Index (PMI) released on Wednesday fell to 50.3 in February, from 51.3 in January. But it remained just above the 50-point mark that separates growth from contraction on a monthly basis - the 19th straight month of expansion.

The sharper drop, however, may raise some concerns for China's leaders as they prepare for the start of the National People's Congress (NPC) next week where Beijing will unveil its economic targets for this year.

Analysts surveyed by Reuters had forecast only a slight easing to 51.2.

Aian shares extended losses on Wednesday and bonds were sold off on the weak factory data, with markets in China and Hong Kong also skidding sharply.

Globally, solid demand has kept many export-reliant economies humming over the past year or so, though a move towards tighter policy in advanced nations could cut into growth this year.

The latest PMI's sub-index of new export orders fell to 49.0, the lowest in at least a year, as the yuan currency appreciated against the dollar.

Chen Zhongtao, an official with China Logistics Information Center (CLIC), said that "13.6 percent of firms reported concerns over the appreciating Chinese currency and greater currency fluctuations," the highest number of companies to do so since March 2017.

CLIC said in a statement export sluggishness is expected to continue this year as steel firms are more reluctant to ship goods in the face of rising global protectionism.


The index for output stood at 50.7, down from 53.5 in January as the Lunar New Year holidays disrupted factory activities, the statistics bureau said. Total new orders also expanded much slower in February.

Raw material input prices fell for the second consecutive month to the lowest since July 2017, indicating cost pressure from price rises on manufacturing firms is easing.

"I think besides the Lunar New Year factor, the stricter pollution measures in the north before the National People's Congress might have weighed on activities as well," said Betty Wang, Senior China Economist at ANZ.

Wang expects momentum to pick up in the months ahead as the pollution crackdown tapers off.

Still, there are signs that China may continue with the pollution crackdown, with top steelmaking city of Tangshan proposing new restrictions on production once the current curbs expire in March.

The week-long Lunar New Year holidays, which fell in February this year but January in 2017, tend to distort data early in the year.

Many factories and offices start to scale back operations ahead of time before shutting for the entire holiday or longer, while some manufacturers front-load shipments or replenish inventories ahead of the break.

CLIC said that steel firms are replenishing their stockpile in anticipation of more demand next month against the backdrop of higher profit returns domestically.

A separate PMI on the steel sector dropped to 49.5 in February from 50.9 in January, impacted by the holidays, pollution curbs and extreme cold weather, CLIC added.


Boosted by government infrastructure spending, a resilient property market and unexpected strength in exports, China's manufacturing and industrial firms helped the economy post better-than-expected growth of 6.9 percent in 2017.

A sister survey showed activity in China's service sector slowed to lowest since October last year in February. The official non-manufacturing Purchasing Managers' Index (PMI) fell to 54.4 from 55.3 in January.

The services sector accounts for over half of China's economy, with rising wages giving Chinese consumers more spending clout.

Chinese policymakers are counting on growth in services and consumption to rebalance their economic growth model from its heavy reliance on investment and exports.

Economists polled by Reuters expected China's economic growth will moderate to around 6.5 percent this year as the property market cools and as authorities press ahead with a clamp down on riskier financial activity that is driving up borrowing costs.

Analysts and financial markets are widely expecting the government to announce a 2018 growth target of around 6.5 percent at the NPC, the same as last year.

A composite PMI covering both the manufacturing and services activity stood at 52.9 in February, down from January's reading of 54.6.

"Looking ahead, we think growth is likely to fall short of expectations this year, with many underestimating the headwinds from slower credit growth and a cooling property sector," Capital Economics' Evans-Pritchard said.

(Reporting by Stella Qiu and Elias Glenn Editing by Shri Navaratnam)