PMI reports on major exporters South Korea and Taiwan also indicated new orders from overseas were falling. The manufacturing sectors in these countries contracted in June for the first time in five months, the reports showed.

In India, where the economy is more reliant on domestic activity, the factory sector picked up in June. But its new export orders growth was the weakest in seven months.

The data increases the risk that the economies of major demand centers Europe and the United States may be weaker than previously thought. Purchasing managers' reports on the two regions are due to be published later on Monday.

The latest sign that China's economy is struggling came on Monday with a private purchasing managers' index (PMI) showing factory activity shrank at its fastest pace in seven months in June. The index slipped to 48.2 from May's 48.4.

The drop was driven by new export orders skidding to depths last seen in March 2009 as demand at home and abroad wilted. The slump dragged prices of finished products from Chinese factories to 42-month lows.

The gloomy outcome mirrored a Chinese government PMI issued on Sunday that also fell to seven-month lows of 50.2 in June from May's 50.4. Though the data was stronger than expected, it still showed growth in the factory sector was close to stalling.

The run of weak data suggested no immediate pick-up for the world's second-biggest economy, a story that is similar in Japan, home to big-brand exporters, such as camera and printer maker Canon Inc (7751.T), which earns about 80 percent of its revenues abroad.

Japan's June PMI, released on Friday, slipped to 49.9, below the 50-point mark that separates expansion from contraction. Japan's index for new export orders dropped to 47.5, the sharpest pace of contraction since February.

PMIs are closely watched as a leading indicator of economic activity. Export orders, especially for major trading nations such as China, Japan and South Korea, point to activity even further into the future and give a sense of the economic health of North America and Europe.

The euro zone's PMI is forecast to show activity still shrinking as the region deals with the debt crisis that has forced five member states to seek international financial support and threatened the future of the bloc.

Europe's manufacturing sector is already languishing at three-year lows as the region's debt crisis batters confidence and saps new orders. The outlook for U.S. manufacturers is brighter, with factories still expanding, albeit more slowly.

POLICY SUPPORT

To shield itself from a possible recession in Europe, and a patchy U.S. economic recovery, analysts believe China needs to further relax monetary policy as early as this month.

Beijing could lower the reserve requirement ratio (RRR), or the level of cash commercial banks must hold as reserves, by another 100 basis points from a lofty 20 percent, analysts say.

The central bank has already cut the ratio three times since November, and surprised financial markets in June by cutting interest rates for the first time since the global financial crisis.

"The further decline in the output, new orders, new export orders components suggests that the China economy still faces downside risks in the near term," said Haibin Zhu, a JPMorgan economist in Hong Kong.

"We expect one more interest rate cut and two more RRR cuts in the third quarter. The next policy move is likely a 50-basis-point RRR cut in July."

The contraction in Japan's factory sector was the first in seven months as a rebuilding boom after the 2011 earthquake and tsunami lost steam.

"This bodes ill for growth heading into the second-half of the year, especially given the fragility of demand in external markets," said Alex Hamilton, an economist at Markit, which gathers the data.

The Bank of Japan has loosened monetary policy this year and the central bank has repeatedly said it is willing to do so again if needed.

The BOJ's tankan survey released on Monday showed big manufacturers were less pessimistic about business conditions in the three months to June compared with the previous quarter.

Many central banks in Asia, and elsewhere, have loosened policy this year as Europe's debt crisis weighed on the global economy.

Most economists polled by Reuters expect the European Central Bank to cut borrowing costs on Thursday in the latest bid to revive the regional economy. But internal resistance to the central bank re-starting its bond-buying program is high.

India's PMI has remained above the 50 level for more than three years, although the country reported its weakest economic growth in nine years in the March quarter at 5.3 percent.

(Additional reporting by Deepti Govind in BANGALORE, Jonathan Standing in TAIPEI, Se Young Lee in SEOUL and Leika Kihara and Rie Ishiguro on TOKYO; Editing by Neil Fullick)

• A Permanent Economic Emergency