Aussie dollar down on poor China Purchasing Managers Index

THE Australian dollar dropped a third of a US cent after HSBC data showed manufacturing in China is contracting at its fastest rate in 28 months.

THE Australian dollar dropped a third of a US cent after HSBC data showed manufacturing in China is contracting at its fastest rate in 28 months.

The dollar fell from 107.48 US cents at 1230 AEST to bottom at 107.13 US cents by 1234 AEST.

At 1300 AEST, it was trading at 107.16 US cents.

The HSBC Flash China Manufacturing Purchasing Managers Index fell to 48.9 in July, from 50.1 in June.

Index levels above 50 indicate growth, while numbers lower than 50 indicate contraction.

Arab Bank Australia treasury dealer David Scutt said the result showed the fastest pace of contraction in China since March 2009.

"Bad news for the China bulls today with manufacturing activity across the nation contracting for the first time in a year," Mr Scutt said.

"With activity softening and recent monetary tightening yet to take full effect, activity is likely to remain subdued in the second half of the year."

Mr Scutt said the data "should be of concern to Australia, given our ever-increasing ties to the world's second-largest economy".

The Australian dollar made small gains in early morning trade after news emerged that France and Germany have reached agreement over how to resolve the Greek debt crisis, ahead of a crucial 17-country summit.

RBC Capital Markets senior economist Su-Lin Ong said the Australian dollar was buoyed by news around 0830 AEST that the euro zone's two major players, France and Germany, may have reached an agreement on how to resolve the Greek debt crisis.

Media outlets are reporting that German Chancellor Angela Merkel has reached a last-minute compromise with France over a fresh bailout for Greece, ahead of crucial summit in Brussels on Thursday night.

"That drove the euro a lot higher this morning, with a risk-on type environment that effectively drove the Aussie dollar higher," Ms Ong said.

The Australian dollar offers higher yields than other currencies while being regarded as more risky, so tends to rise when there is good financial news and declines when news is bad.

European Union leaders are expected to craft a second rescue package of up to 120 billion euros ($A159.25 billion) for Greece when they gather in Brussels.

Ms Ong said the market would wait for more details from the summit during tonight's offshore session.

Meanwhile, bonds rallied on the the pessimistic outlook for Chinese manufacturing.

At 1310 AEST, the September 10-year bond futures contract was trading at 95.025 (implying a yield of 4.975 per cent), down from 95.035 (4.965 per cent) on Wednesday.

The September three-year bond futures contract was at 95.590 (4.410 per cent), steady from Wednesday.