A worker prepares to unload steel bricks at a steel factory on the outskirts of Jammu in India on July 10, 2014.

New Delhi - Indian factory output surged to a 17-month peak in July, according to a key business survey Friday, fuelling recovery hopes in Asia's third-largest economy.

But the HSBC Purchasing Managers' Index (PMI), keenly watched as a harbinger of industrial expansion and overall economic health, also flagged inflation worries ahead of a key monetary policy meeting next week.

The PMI survey jumped a full 1.5 points to 53.0 last month - its best performance since February 2013.

A reading of over 50 points suggests expansion while under 50 indicates contraction.

“A flood of new orders from both domestic and external sources has led to a surge in activity,” Frederic Neumann, HSBC Asian research co-head said.

“Finally, the manufacturing sector is starting to pick up steam,” Neumann said.

The output and order rise was across the board, Neumann noted, boosting hopes the economy could be rallying from its deepest slowdown in a quarter-century.

Business confidence has been building that Premier Narendra Modi's right-wing government, which took office in late May, will initiate policy changes to spur growth, despite a budget last month that eschewed radical reforms.

The PMI results coincided with a government survey in neighbouring China showing manufacturing activity rose in July at its fastest pace in over two years.

However, the Indian PMI survey also stoked inflation worries ahead of a central bank monetary policy-setting meeting next Tuesday.

Input prices accelerated at their fastest pace since February, the survey found, suggesting inflation could stay high as firms seek to recover mounting costs.

“The speed of the recovery has also lifted price pressures” which means the central bank “may not cheer as loudly as the rest of us” about the PMI readings, said Neumann.

Industry has been clamouring for the hawkish bank to cut interest rates from a steep eight percent to spur growth that was 4.7 percent in the last financial year to March 2014 - down from nearly nine percent as recently as in 2011.

But most economists expect no cut in rates until at least the first quarter of the next financial year with consumer price inflation riding at 7.31 percent - far above the bank's six-percent target.

Some say it is impossible to dismiss chances of a rate hike, although not immediately, as below-normal monsoon rains threaten to push up food prices while Middle East tensions could raise crude oil costs in an economy heavily dependent on imported fuel.

Still, the survey's overall tone was upbeat, showing new orders - an important sub-category and portent of future activity -

growing at the fastest clip in 17 months. - Sapa-AFP