China's big factories were surprisingly busy in March as a stream of new orders lifted activity to an 11-month high, but credit-constrained smaller manufacturers struggled, suggesting that the economy is still losing steam.

The pickup in production at large factories was attributed to an expected bump as winter ends, and economists cautioned not to read too much into the stronger-than-expected figure.

That left intact a view that China's economy, while not crashing, likely suffered its worst quarter in three years between January and March, and requires at least some monetary policy easing this year to ensure the cool down stays mild.

Still, hopes for a turnaround were kept alive on Sunday when the official Purchasing Managers' Index (PMI) that highlights large factories jumped to an 11-month high of 53.1 in March, up from February's 51 comfortably beating forecasts of 50.5.

The number will likely cheer financial markets on Monday by dispelling talk that China is sliding towards a hard landing, although Nomura economist Zhang Zhiwei said the figure is not as impressive after accounting for seasonal changes.

I don't think the economy has improved a lot, he said. If you take out the seasonality factor, this year's jump is less than the historical average. From that perspective, it's not a very strong signal.

INFLATION AND GROWTH

Data between 2005 and 2010 showed the PMI climbing at least 3 points each year in March from February, a trend Zhang attributed to factories revving up production when winter ends.

The pressure for the government to loosen monetary policy is still building up, said Zhang, who forecasts China will this year cut interest rates by 25 basis points and reduce the cash banks hold as reserves by 100 basis points.

Loan demand is very weak. It's not a supply issue but a domestic demand issue. Domestic demand is weak.

Beijing has set a 7.5 percent growth target for 2012, which would be the slowest pace in more than a decade, aiming for a more sustainable economy that is less vulnerable to inflation and gentler on the environment.

The question is whether policymakers can orchestrate a mild slowdown. Sunday's data left that unanswered.

One clue will come in bank lending data for March, due in mid-April, on whether Beijing can relax stiff domestic credit conditions in time to shore up growth. If it succeeds, analysts say China's economy may have seen the worse in the first quarter.

SLOWDOWN AT SMALLER FACTORIES

But a private survey of smaller factories by HSBC showed a worsening slowdown. The HSBC PMI fell to 48.3 in March from February's 49.6, largely in line with a flash PMI reading of 48.1 released in March.

It was fifth successive month that the HSBC PMI has missed the 50-point level that separates expansion from contraction in activity, pushing the PMI into its worst quarter in three years between January and March, HSBC said.

The HSBC PMI showed fewer new orders in March for small private factories, which unlike state-owned companies, have less access to bank loans and have borne the brunt of the latest economic slowdown.

Worryingly, HSBC's figures also showed factory inflation picking up too. Slower growth and rising inflation would be the worst of both worlds.

Final (HSBC) PMI results confirm a further slowdown of growth momentum, weighed by weakening new export orders, said Qu Hongbin, an economist at HSBC. Weaker export growth is likely to prompt further easing measures.

A Reuters poll in March showed analysts expect China's central bank to lower the ratio of cash banks must hold as reserves by another 150 basis points this year.

DISPARITY

A breakdown of the official PMI -- which focuses on large state-owned factories -- showed a broad rebound in production, with seemingly buoyant domestic demand pushing the new orders sub-index to 55.1 in March, from February's 51.

Demand overseas was markedly more muted, with the sub-index for new export orders rising to 51.9, from February's 51.1.

China's vast factory sector, which accounted for 40 percent of its economy in 2010, had cooled steadily in the past year as tight domestic monetary conditions aggravated waning global demand. Output hit 2-1/2-year lows in January and February.

Judging from market demand and the state of economic growth, the economy is still likely to slow in the future, said Zhang Liqun, a researcher with the Development Research Centre of the State Council.

We would need to analyze the discrepancy between the PMI and the actual state of the economy.

(Reporting by Koh Gui Qing and Benjamin Kang Lim; Editing by Ed Lane)

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