China's factory activity falls faster than expected as recovery stumbles

China's factory activity contracted faster than expected in May on weakening demand, heaping pressure on policymakers to shore up a patchy economic recovery and knocking Asian financial markets lower.

The official manufacturing purchasing managers' index (PMI) fell to 48.8 from 49.2 in April, according to data from the National Bureau of Statistics (NBS), its lowest in five months and below the 50-point mark that separates expansion from contraction. The PMI also dashed forecasts for an increase to 49.4.

Service sector activity expanded at the slowest pace in four months in May, with the official non-manufacturing PMI falling to 54.5 from 56.4 in April.

The readings pushed markets in Asia lower with the yuan and Australian and New Zealand dollars tumbling and regional stocks falling sharply.

"The PMI data reveal that China may heading to a K-shaped recovery," said Bruce Pang, chief economist at Jones Lang LaSalle.

"The sluggish domestic demand could weigh on China's sustainable growth, if there are no efficient and effective policy moves to engineer a broad-based recovery," said Pang.

China's economy is emerging from three years of pandemic lockdowns, but the recovery has been uneven with services spending outperforming activity in the factory, property and export-oriented sectors.

The PMIs and other economic indicators for April add to evidence that the rebound is losing steam.

Last month, imports contracted sharply, factory gate prices fell, property investment slumped, new bank loans tumbled, industrial profits plunged and factory output and retail sales both missed forecasts.

Nomura, Barclays have both cut China's 2023 GDP growth forecasts as the recovery sputters.

"Proactive fiscal policies, rate cuts or RRR cuts and targeted monetary policy tools together with structural reform would be key," Pang added.

To spur credit growth, the central bank in March cut banks' reserve requirement ratios.

Premier Li Qiang said this month more targeted measures were needed to boost demand while China's central bank said on May 15 it would provide "strong and stable" support for the real economy.

"The sentiment in the financial market is quite bearish. It is not clear how the government interpret the current economic condition," said Zhiwei Zhang, chief economist at Pinpoint Asset Management. "There is no sign of imminent policy response. The government may continue to take a 'wait and see' stance for now."