The news came as Beijing announced it would allow its yuan currency to fluctuate more widely within its trading band as a way to support the trade sector.

Fears of faltering demand in the world's largest commodity buyer piled further pressure on resource prices, sending gold to a five-year low and copper to a six-year trough.

It also added to the woes of emerging market nations already struggling with the risk of a rise in U.S. interest rates later this year.

The flash Caixin/Markit China Purchasing Managers' Index (PMI) dropped to 48.2, the lowest reading since April last year and the fifth straight month under 50, the level which the survey-makers say separates contraction from expansion. According to government data, industrial output is still rising.

The drop confounded forecasts for a rise to 49.7, from June's final reading of 49.4, and slugged the Australian dollar to a six-year low.

China is Australia's biggest export market and investors use the currency as a liquid proxy for risk in the Asian giant.

The survey of executives in over 420 Chinese manufacturing firms found output, new orders and export orders all decreased.

"Today, it's big, bad news with this number well below consensus," said analyst Helen Lau of Argonaut Securities in Hong Kong. "It shows there's no signs of recovery in small and mid-sized business in China, but I think it's also related to the summer weak season for demand."

The China survey overshadowed better new from Japan where the flash Markit/Nikkei PMI rose to a seasonally adjusted 51.4 in July, from a final 50.1 in June, a welcome hint of economic acceleration after a surprise slowdown last quarter.

Notably, new orders in Japan pushed into positive territory which might help explain recent data showing firms are becoming more confident about increasing capital spending.

Yet the survey also found a slowdown in export orders, a trend that is bedeviling Asia and emerging markets generally.

Emerging Strains

Expectations of a U.S. rate rise this year have already dented investor appetite for high-yielding but risky emerging market assets. The latest Reuters poll found a majority of analysts now believe the Federal Reserve will hike in September.

The ripples are being felt far and wide. Aberdeen Asset Management on Thursday reported investors withdrew almost 10 billion pounds ($15.6 billion) over the past three months to cut exposure to Asia and emerging market equities.

The closely-watched MSCI emerging market index has fallen 13 percent since late April as commodity prices entered a new bear phase. In the same period, the Thomson Reuters CRB index of commodities has shed 10 percent to within a whisker of its lowest since 2009.

Earlier in the week, Goldman Sachs slashed its outlook for copper prices citing expectations of lower Chinese demand and expanding supply.

The combination of weak resource prices and a strong U.S. dollar is proving a headache for policymakers.

South Africa's Reserve Bank on Thursday raised rates for the first time in a year in an attempt to head off inflationary pressure from a falling rand.

"The rand remains vulnerable to global market reaction to U.S. monetary policy normalization," warned Governor Lesetja Kganyago, adding that Fed tightening would likely trigger an "exchange rate-inflation spiral."