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Euro zone manufacturing activity contracted for the first time in almost two years in August due to a sharp downturn in output and new orders, a key business survey showed on Thursday.

In a worrying sign for policymakers, the slowdown appears to be spreading, with German factories, which have supported growth in the bloc for some time, hitting the brakes while France's manufacturing sector contracted for the first time since July 2009.

The Markit Eurozone Manufacturing Purchasing Managers Index (PMI), which gauges changes in activity levels across thousands of euro zone manufacturers, fell to 49.0 in August from 50.4 in July. The August figure was revised down from a preliminary 49.7.

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It is the first time since September 2009 that the index for the sector, which drove a large part of the bloc's recovery, has fallen below the 50 mark that divides growth from contraction.

"Final PMI data for August were even worse than the disappointing earlier flash numbers, signalling an end to the manufacturing recovery which began in October 2009," said Chris Williamson at data provider Markit.

The output index, which feeds into the broader composite index released next week that gives an indication of economic growth, sank from July's 50.2 to 48.9, revised down from a flash reading of 50.0 and marking its first sub-50 reading since July 2009.

The outlook is far from rosy as new orders fell for the third straight month. The sub-index fell to 46.0, down from the preliminary 46.9 reading and much lower than July's 47.6.

"The forward-looking indicators also sent worrying signals. New orders fell at the fastest rate since June 2009, with declining demand for goods now reported in all countries surveyed," Mr. Williamson said.

Firms did take on new workers last month, but at the slowest pace in nearly a year, suggesting they may look to cut production further in coming months.

Earlier data from Germany, Europe's largest economy, showed its manufacturing PMI fell to 50.9 from July's 52.0, while in France the index slumped to 49.1 from July's 50.5.

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Italy's manufacturing sector returned to contractionary territory, having barely grown in July, while in Spain the sector contracted for the fourth consecutive month.

Economists polled by Reuters in August said they expected steady but slow growth in the euro zone over the next year. Coupled with the ongoing debt crisis, this has led them to push back expectations for the next rate hike by the European Central Bank to the end of next year.

The PMIs suggested price pressures were easing, but official flash data released on Wednesday showed inflation in the 17-nation bloc held steady at 2.5 per cent last month, above the central bank's 2 per cent target ceiling.

Euro zone manufacturing contracts in August -PMI

* Manufacturing sector contracts for first time in 2 years

* Factory output lowest since June 2009

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* New orders contract for third month

By Jonathan Cable

LONDON, Sept 1 (Reuters) -

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