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Widespread manufacturing woes test fragile global economy

Mounting manufacturing woes at opposite ends of the planet portend deepening trouble for the fragile global economy.

In China, manufacturing slowed to its lowest level in nine months, European factory output continues to shrink and the latest U.S. readings are consistent with feeble economic and job growth.

This latest batch of troubling signals – combined with fresh worries about the damage wreaked by the burgeoning European debt crisis – has triggered a selloff in global equity markets. As well, central banks in China, the United States and Europe are being called on to ride to the rescue with more stimulus and bailout measures.

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The trouble in the world's workshops stems from the recession in Western Europe amid a spreading debt crisis and the stumbling recovery in the United States.

China, once viewed as the saviour that would reignite global growth, has not been able to replace falling demand from the United States and the European Union, by far its biggest customers, to keep its export-driven manufacturing machine humming.

This in turn spells headaches for Canada and additional suppliers of base metals and other industrial commodities, as demand falters and prices weaken. Chinese steel prices have already fallen to their lowest level in three years.

In China, the HSBC flash purchasing managers index (PMI) – a survey of people who base their spending on materials and other supplies on their expectations of demand – slid to 47.8 this month from 49.5 in July. That marks the 10th consecutive month below 50, the line that separates growth from contraction.

The preliminary survey offers the earliest look at factory orders for China's small and mid-sized manufacturers, the ones hardest hit by a drop in export demand.

"We reiterate our view that the August macro data, like that in July, will likely prove to be the worst in the current economic down-cycle," Na Liu, founder of CNC Asset Management Ltd. and a China adviser to Scotia Capital Inc., said in a note.

Mr. Liu and several other China watchers suggest Beijing may be forced to respond with new stimulus measures.

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"The financial markets have responded to the weak PMI data positively overnight, reflecting investor beliefs that the economy has slowed to a level that calls for more action from policy makers," Mr. Liu said.

"This has added to our worries about the outlook for China's growth and it has added concern about whether the government response to the economic slowdown is adequate," said Xianfang Ren, chief China economist for IHS Global Insight.

"It sends a very negative signal, possibly pointing to a very weak exports sector for the next couple of months. … If that is the case, the government may have to ramp up fiscal and monetary stimulus."

The People's Bank of China on Thursday injected 220 billion yuan – $34.6-billion (U.S.) – into the banking system, in an effort to boost lending, after new loans in July totalled just 540 billion yuan, the lowest in a year.

The move is seen as a stand-in for a further cut in banks' required reserve ratios. Authorities remain wary of encouraging a stubbornly inflated property market. But as a fine-tuning measure, the increase in capital will satisfy neither critics looking for a larger stimulus package in the form of infrastructure spending nor those calling for deeper, structural economic reforms.

"We just don't think there are big stimulus plans and do not expect the recovery to be quick or strong," warned Wang Tao, chief China economist with UBS Securities.

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In the United States, the equivalent Markit preliminary purchasing managers index for August rose to 51.9 from a final July tally of 51.4, the third-weakest level in nearly three years. But apart from the volatile commercial aircraft sector, where Boeing booked large orders in July, analysts are expecting no significant gains in new durable goods orders or employment, which rose at its slowest pace since the end of 2010. Rising initial jobless claims last week underscore the labour market problems in the United States, where employers remain reluctant to add workers in an uncertain climate.

In the euro zone, the flash PMI factory number for August was slightly higher than the final July reading. But this "does nothing to challenge the notion that the single currency area is now firmly in recession," said Jonathan Loynes, chief European economist with Capital Economics in London.

The manufacturing component of the survey edged up to 45.3 from 44.0, the highest level in four months. But the services index slid to 47.5 from 47.9. "Over all, yet another reminder that a chronic lack of economic growth in the euro zone will continue to impede efforts to bring the debt crisis to an end," Mr. Loynes said in a note.

On that front, the Spanish government is talking to its euro-zone partners about the possible conditions for assistance to reduce its borrowing costs, which are unsustainable at current market rates. But Madrid has not yet requested a full-scale bailout, Reuters reported, citing unnamed sources.

Both fiscally battered Spain and Italy favour a plan that would see the existing European rescue fund and its intended successor buy their sovereign bonds at primary auctions to shore up prices, while the European Central Bank would resume its intervention in the secondary market.

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