A rising Australian dollar, coupled with cost increases and low domestic demand has pushed Australia's manufacturing sector to post its lowest ever growth in three years in July, which could also get worse with the implementation of the carbon tax.

The Australian Industry Group-PricewaterhouseCoopers Australian Performance of Manufacturing Index, in a survey released on Tuesday, dropped 6.9 points to 40.3 in the month, way below the 50 point mark reading that divorces expansion from contraction. A reading below 50 indicates a contraction. It was the weakest reading since June 2009 and fifth drop in six months.

In July, the Australian dollar rose 2.6 per cent versus the US dollar and was considered the best performer among 16 major currencies, according to Bloomberg. However, the reality of the continued global fiscal crisis and the resulting global slowdown has started to take its toll on Australian companies. Many employers reduced manpower in June, the first in four months. Unemployment rate likewise continues to rise.

"Falls in manufacturing production and employment were the major factors behind the sharp drop in the Australian PMI," Innes Willox, chief executive officer at AIG, said in a statement. "The industry is experiencing substantial pressures driven by the strong dollar, cost increases, slow growth in domestic demand and competition from lower cost sources of production."

The manufacturing survey involved more than 200 companies about new orders, production, employment, deliveries, and inventories.

And the implementation of the carbon tax in July offers no remote consolation that conditions will improve in the coming months for Australia's manufacturing sector.

"Manufacturers are responding by reassessing and re-modelling their businesses but, as suggested by another drop in new orders and with the full impact of the carbon tax still to be felt, further falls in overall activity are likely in the months ahead," Innes Willox, chief executive of Ai Group, said.

Australia began charging its largest polluters for carbon emissions on July 1 in line with a 5 per cent cut in pollution from 2000 levels by 2020.

At 11am AEST, the Australian dollar was at $US1.0492.