BEIJING (Reuters) - Factory activity in China unexpectedly grew for the first time in four months in March, an official survey showed on Sunday, suggesting government stimulus measures may be starting to take hold in the world’s second largest economy.

FILE PHOTO: Employees work on the production line of a factory manufacturing fashion accessories in Sihong county, Jiangsu province, China March 27, 2019. REUTERS/Stringer

If sustained, the improvement in business conditions could indicate that manufacturing is on a path to recovery, easing fears that China could slip into a sharper economic downturn.

But analysts remained cautious, citing seasonal distortions due to the long lunar New Year break in February. They said real investment and consumer demand remained soft and pushed up inventories, potentially adding pressure to the sector.

The official Purchasing Managers’ Index (PMI) rose to 50.5 in March from February’s three-year low of 49.2, marking the first expansion in four months, according to data released by the National Bureau of Statistics (NBS) on Sunday. The 50-mark separates growth from contraction on a monthly basis.

Analysts surveyed by Reuters had forecast the manufacturing gauge would pick up slightly to 49.5, as factories ramped up production after the Lunar New Year holidays and rebuilt inventories ahead of a seasonal pickup in activity in spring.

Factory output grew at its fastest pace in six months in March, reversing a brief contraction in the previous month. It rose to 52.7 from February’s 49.5, the highest level seen since September 2018.

Total new orders also grew at a quicker pace, driving up factory-gate prices to a five-month high of 51.4, ending four months of contraction.

“The jump will likely give a big boost to stock markets and could delay a cut in the reserve requirement ratio (RRR),” said Ting Lu, chief China economist at Nomura.

China has announced five RRR cuts in the past year to free up more cash for banks to boost lending to private firms, and further cuts are widely expected.

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Ting said there is limited room for manufacturing PMI to rise further and the chance for another dip is “not small”.

“Overall, although the manufacturing PMI in March can somewhat alleviate the pessimistic expectations of the economy, we believe that the actual situation may not be so optimistic as reflected in this indicator,” Lianxun Securities said in a note.

Export orders shrank for the 10th straight month, suggesting external demand remained sluggish and further policy cushion may be needed if trade tensions escalate. China’s trade-oriented neighbors Japan, South Korea and Taiwan have seen more signs of slackening demand, both in China and elsewhere.

“Construction work starting at the beginning of the year has led to strong domestic demand, but external demand is still weak, and the outlook on imports and exports is still not optimistic,” economists at Huatai Securities said.

Tit-for-tat tariffs imposed by Washington and Beijing remain in place as talks continue to end a trade war that has disrupted the flow of billions of dollars of goods between the world’s two largest economies.

U.S. President Donald Trump said on Friday that talks with China were going very well, but added he would not accept anything less than a “great deal” after top trade officials wrapped up two days of discussions in Beijing.

SPECTER OF LAYOFFS

Factories shed more staff in March, with the employment sub-index still hovering below the no-change mark of 50. It edged up marginally to 47.6 from 47.5 in February.

Amid rising labor costs and weaker sales, foreign companies from car makers to electronics firms have decided to shut plants in China in recent months, raising the specter of more layoffs.

Sony Corp is closing its Beijing smartphone plant, while Samsung Electronics ceased operations at one of its mobile phone manufacturing plants last year.

The jobless rate in February rose to 5.3 percent, nearing a two-year high.

The PMI survey showed small and mid-sized manufacturers still fared worse than large companies, many state-controlled, although their activity improved from the previous month, suggesting that policymakers’ efforts to channel affordable financing to the private sector are gradually working.

Policymakers have acknowledged the economy is under pressure. Multi-year campaigns to curb debt risks and pollution have deterred fresh investment, while the U.S.-China trade war is hurting China’s export sector, threatening even more jobs.

In response, Beijing plans more spending on roads, railways and ports, along with nearly 2 trillion yuan ($297.27 billion) in tax cuts to ease the pressure on corporate balance sheets.

The measures will take time to kick in, say analysts who believe economic activity may not stabilize until the middle of the year. Data on Wednesday showed industrial profits fell 14 percent in the first two months of the year, the sharpest drop since at least late 2011.

In the steel industry, steel mills are facing calls to restrain output as the flooding of products in the market severely dents profit margins in the sector.

Growth in China’s services industry - accounting for over half of the economy - picked up in March as new orders rose more quickly. The official non-manufacturing Purchasing Managers’ Index (PMI) rose to 54.8 from 54.3.

Construction activity swung back into high gear in March with the return of warm weather. A sub-reading for construction activity stood at 61.7 in March, up from 59.2 in February.