BEIJING (Reuters) - China's factory activity weakened to a nine-month low in June as demand faltered, a preliminary survey showed, heightening risks that a second quarter slowdown could be sharper than expected and raising the heat on the central bank to loosen policy.

The flash HSBC Purchasing Managers' Index fell to 48.3 in June from May's final reading of 49.2, drifting further away from the 50-point level demarcating expansion from contraction. It was the weakest level since September.

"Manufacturing sectors are weighed down by deteriorating external demand, moderating domestic demand and rising destocking pressures," said Qu Hongbin, chief China economist at HSBC.

"Beijing prefers to use reforms rather than stimulus to sustain growth. While reforms can boost long-term growth prospects, they will have a limited impact in the short-term. As such we expect slightly weaker growth in 2Q."

China's economy grew at its slowest pace for 13 years in 2012 and so far this year economic data has underwhelmed, bringing warnings from some analysts that the country could miss its growth target of 7.5 percent for this year.

The Australian dollar hit a fresh 33-month low after the latest bearish data, which fuelled worries about a slowdown in Australia's single biggest export market. Most of Asia's main share markets were down more than 1 percent, with the Asia ex-Japan index <.miapj0000pus> down 2.8 percent.

In the survey, a sub-index measuring overall new orders dropped to 47.1 in June, the lowest reading in 10 months, suggesting demand is weakening both at home and abroad.

The survey, compiled by British-based Markit Group Ltd, also showed new export orders weakened further in June, pointing to persistent global headwinds as the U.S. recovery remains patchy, while Europe's economy remains shackled by the debt crisis.
An employment sub-index also eased in June - broadly in line with signs of softening demand for migrant workers in Chinese cities - even though the overall job market is holding up as the government tries to improve social safety nets.

WEAK Q2

Most analysts expect annual economic growth in the second quarter to weaken slightly from the 7.7 percent annual pace in the first quarter. Growth in the first three months had slowed from 7.9 percent in the previous quarter despite a credit boom.

Weak data in April and May has prompted many analysts to cut their forecasts for China's 2013 economic growth.

Barclays Capital, which expects annual economic growth to slow to 7.5 percent in the second quarter, has cut its forecast on the full-year growth rate 7.4 percent from 7.9 percent.

HSBC has cut its 2013 growth forecast to 7.4 percent from 8.2 percent and its 2014 outlook to 7.4 percent from 8.4 percent.

Economists at ANZ said in a research note published on Tuesday that a rapid cooling of inflation and weaker domestic demand meant the time was right for the central bank to cut interest rates to revive the economy.

But the central bank, which last cut rates in July 2012, looks to be treading cautiously in easing policy that could inflate a property bubble even as consumer inflation cools.

China's consumer inflation slowed to 2.1 percent in May, the lowest in three months, but data on Tuesday showed that home prices rose at their fastest pace this year, highlighting the dilemma facing policymakers under pressures to support the economy while deflating a property bubble.

The chances of fresh stimulus appear slim given that China's new leaders have adopted a greater tolerance for a slowing economy than their predecessors as they focus on economic reforms rather than short-term boosts.

Government economists told Reuters that the new leadership of President Xi Jinping and Premier Li Keqiang would tolerate quarterly growth slipping as far as 7 percent year-on-year before looking to jumpstart the economy.

Premier Li Keqiang was quoted by state media as saying on Tuesday that the economy remains generally stable and the pace of expansion is still within "the reasonable range".

"We are able to overcome difficulties and achieve the full-year economic development task," Li was quoted as saying.

The Financial News, which is run by the central bank, said in a commentary on Wednesday that the chances of a near-term interest rate cut remain low amid fears over capital outflows.

The newspaper also shrugged off suggestions that the central bank should cut banks' reserve requirement ratio (RRR) to boost liquidity amid signs of an inter-bank funding squeeze.

Beijing is still nursing the hangover from its 4 trillion yuan ($652.7 billion) stimulus package implemented during the depths of the global crisis in 2008-09, which fuelled a property bubble and saddled local governments with a pile of debt.

The HSBC flash PMI comes ahead of the final reading, which is due to be released on July 1 along with the Chinese government's official PMI.

($1 = 6.1285 Chinese yuan)
(Editing by Alex Richardson)

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