* Manufacturing sector shrinks at slowest pace in 11 months
* New orders fall at slowest pace in 16 months
* Steepest contraction in finished goods stocks in 10 years
By Daniel Flynn
ROME, Aug 3 (Reuters) - Italy's manufacturing sector shrank at its slowest pace in 11 months in July thanks to a stabilisation in production and new orders, but conditions in the labour market remained weak, data showed on Monday.
The latest Markit/ADACI survey produced a headline Purchasing Managers' Index of 45.4 -- below the 50 threshold where growth begins but above March's record low of 34.6. Production at Italian factories fell for the 16th straight month in July, albeit at the slowest pace since August 2008. The industrial sector accounts for around a quarter of gross domestic product in the euro zone's third largest economy.
New orders continued to decline, but at their slowest rate in 16 months, spurring hopes of an economic recovery. The sub index rose sharply to 46.7, from 42.7 the previous month.
Nonetheless, it was the nineteenth consecutive fall in new orders: approximately 32 percent of panel members reported that order books declined, with a more pronounced drop from overseas.
"This suggested that international demand deteriorated at a marginally steeper pace than demand in the domestic economy," Markit wrote in its report.
Panellists reported that poor liquidity and access to credit remained key factors weighing on performance.
Companies continued to work through backlogs of orders and cut jobs, demonstrating continued spare capacity. Firms cited declining workloads as the main factor for laying off staff.
With demand weak, panellists said they preferred to deplete stocks rather than boost output -- July showed the steepest contraction in stocks of finished goods for almost 10 years.
The depreciation of the U.S. dollar and falling raw material costs meant a ninth consecutive monthly fall in average costs for Italian manufacturers, but the rate of price deflation was the weakest in the current downturn.
Due to stiff competition for market share and falling costs, factory gate prices fell again in July, but at their slowest rate since November. It was the tenth consecutive monthly fall.
Broken down by industrial sector, consumer goods showed the sharpest fall in output, while investment goods industries showed a markedly slower decline in activity. (Editing by Andy Bruce)