Japan's factory activity shrank at a slower pace in December as declines in production and new orders eased, a private-sector survey showed on Monday, edging closer to stabilisation after recent falls.

The final au Jibun Bank Japan manufacturing purchasing managers' index (PMI) rose to 49.6 in December, indicating the softest contraction in three months. The index was slightly higher than 49.5 in the flash reading and 49.0 in November but stayed below the 50.0 threshold that separates growth from contraction for the sixth straight month.

"The headline reading moved closer to neutrality amid softer reductions in both production and new order intakes," said Usamah Bhatti at S&P Global Market Intelligence, which compiled the survey.

The subindex of production shrank for a fourth straight month in December but the contraction was also slower than last month. Manufacturers noted that subdued new orders were the main factor behind the decline in output.

New orders contracted for the 19th straight month on subdued demand in both domestic and key overseas markets. Some firms in the survey suggested the semiconductor market was behind the weakness in new orders.

Employment expanded in December, reversing its fall in November, to reach its highest level since April. Firms in the survey said they hired more workers due to labour shortages as well as in preparation for future demand.

Input prices grew at the strongest pace since August, with firms citing higher costs of raw materials and labour. The weak yen also boosted inflation. To cope with rising prices, firms raised their output prices at the fastest rate in five months.

Manufacturers stayed confident about their outlook as they expect business to expand thanks to the launch and mass production of new products.