By Sue-Lin Wong

BEIJING (Reuters) - Activity in China's manufacturing sector eased unexpectedly in July as orders cooled and flooding disrupted business, an official survey showed, adding to fears the economy will slow in coming months unless the government steps up a huge spending spree.

While a similar private survey showed business picked up for the first time in 17 months, the increase was only slight and the much larger official survey on Monday suggested China's overall industrial activity remains sluggish at best.

Both surveys showed persistently weak demand at home and abroad were forcing companies to continue to shed jobs, even as Beijing vows to shut more industrial overcapacity that could lead to larger layoffs.

And other readings on Monday pointed to signs of cooling in both the construction industry and real estate, which were key drivers behind better-than-expected economic growth in the second quarter.

The official Purchasing Managers' Index (PMI) eased to 49.9 in July from the previous month's 50.0 and below the 50-point mark that separates growth from contraction on a monthly basis.

Analysts polled by Reuters predicted a level of 50.0.

While the July reading showed only a slight loss of momentum, Nomura's chief China economist Yang Zhao said it may be a sign that the impact of stimulus measures earlier this year may already be wearing off.

That has created a dilemma for Beijing as the Communist Party seeks to deliver on official targets, even as concerns grow about the risks of prolonged, debt-fueled stimulus.

"The government has realized the downward pressure is great but they've also realized that stimulus to stimulate the economy continuously is not a good idea and they want to continue to focus on reform and deleveraging," Zhao said.

Heavy flooding, particularly along the Yangtze River, contributed to July's manufacturing contraction along with slowing demand and the cutting of overcapacity in some industries, the statistics bureau said.

Falling activity at smaller firms also was a key reason for July's poor figure, the statistics bureau said, but performance at larger companies improved, in a sign that the government is becoming more reliant on big state firms to generate growth.


"Today's data do not bode well for GDP growth in the second half," ANZ economists Louis Lam and David Qu wrote in a note.

Fiscal policy would be the key tool for boosting growth in coming months, while the central bank was expected to keep its policy settings accommodative, they added.

While many analysts believe the world's second-largest economy may be slowly stabilizing, conditions still look patchy.

Industrial profits rose at the fastest pace in three months in June, but gains were concentrated in just a few industries including electronics, steel and oil processing.

Spurred by rebounding prices and stronger construction demand, China's steel output and exports have been near record levels. But it one of the key sectors being targeted by officials for capacity cuts and tougher pollution controls.

Indeed, the PMI showed factory output in July still expanded solidly, though the pace cooled to 52.1 from 52.5 in June.

Total new orders hovered just inside expansionary territory at 50.4, slightly down from June, but new export orders contracted as overseas demand remains weak and the impact of Britain's vote to leave the European Union hurt sentiment.

A private PMI survey by Caixin/Markit was more mixed.

Its 50.6 reading was stronger than expected and the first expansion since February 2015, sparking hopes that some of the government's stimulus was starting to trickle down to smaller private firms which have been under greater stress than larger state-backed enterprises.

But overall order growth was modest and export orders continued to fall.

The Caixin report tends to give more weight to light industry, whereas the official survey is skewed more toward heavy industries, said Zhengsheng Zhong, director of macroeconomic analysis at CEBM Group, according to Caixin.

An official survey on the services sector was more upbeat, showing growth accelerated to 53.9 in July from 53.7 in June.

But it, too, contained several worrying notes, with construction services growth solid but cooling and the property services sector weakening, adding to worries that China's housing boom may have peaked.

    Beijing has been counting on a strong services sector to pick up the slack as it tries to shift the economy away from a dependence on heavy industry and manufacturing exports.

(Reporting by Yawen Chen, Elias Glenn and Sue-Lin Wong; Editing by Kim Coghill)