The figures -- which show manufacturing exports down for a 10th straight month, with prices and production also falling -- come a day before the central bank makes a decision on whether to hike interest rates.
The Australian Industry Group-PricewaterhouseCoopers Performance of Manufacturing Index (PMI) fell 9.5 points in July to 43.4.
A reading below 50 indicates a contraction in activity while anything above 50 suggests expansion.
Nine of the 12 sectors surveyed declined in July, up from six the previous month, with wood products and furniture and clothing and footwear the hardest hit.
New orders slumped 14.4 points to 40.2 in the month across all sectors, and employment shrank for a ninth straight month.
The results reinforce "the very tough trading conditions the industry is experiencing", the AIG-PwC index report said.
"Increased competition from cheaper imports, the soft housing market and weak consumer confidence," were the main drivers of the slump," the report added.
The poor figures follow a brief up tick in June linked to the recovery from the summer's cyclones and floods.
Dubbed the "Wonder from Down Under" for its world-beating performance during the global downturn, Australia's economy has hit some turbulence in 2011, with natural disasters slashing growth and fanning inflation.
Consumer confidence slumped to recession levels in July, with the kind of monthly fall usually associated with a significant economic shock.
Major retailers have slashed profit forecasts and closed stores as they battle increasingly cautious consumers and the Australian dollar, which last week hit its highest level against the greenback since it was floated in 1983.
The "Aussie" has been near or above parity with the greenback for about 10 months and hit its new high after figures showed inflation in the June quarter was higher.
International travel surge to record levels and online retail jump 13 percent in 2010 to Aus$13.6 (US$15 billion) -- almost half of which went offshore -- as cashed-up Australians seek to capitalise on the strong currency.
Manufacturing wages jumped 9.3 points in July, the 27th month they have increased, and input prices were higher for the 110th month in a row, squeezing profit margins.
Monday's news will provide a headache for the Reserve Bank of Australia as it must weigh up the impact of another rate hike on the economy while also trying to rein in rising prices.
Last week data showed inflation unexpectedly rose in the three months to June.
Copyright AFP (Agence France-Presse), 2011