The Australian Industry Group-PricewaterhouseCoopers Australian performance of Manufacturing Index (PMI) rose 0.1 index points to 47 points in August.
While an improvement on the July figure, the result was still below the key 50 level that separates expansion from contraction.
"Tighter financial conditions have driven an easing of consumer demand and weaker housing construction, which have reduced demand for manufactures," the survey, released on Monday, said.
A weak retail sector, the higher cost and shortage of raw materials and competition from imports also hurt manufacturers.
But they were aided by continued strong demand from Australia's mining boom and demand for infrastructure.
PricewaterhouseCoopers global leader of industrial manufacturing Graeme Billings said he expected tough operating conditions to remain for some time.
"It is unlikely that these market pressures will ease significantly in the short term, given the prospect of slower economic growth, both here and overseas," Billings said in a statement.
"It is also unlikely that the long-term pressures facing manufacturers due to a higher exchange rate, skills shortages and competitive pressures from the emerging manufacturers such as China will abate significantly either."
Ai Group chief executive Heather Ridout said manufacturing was caught in a bind between falling demand and higher input costs.
"With new orders falling sharply and the price of inputs continuing to rise, the Australian PMI clearly shows there is increasing pressure on future production," Ridout said in a statement.
Ridout said the contraction provided a "compelling" case for an interest rate cut at Tuesday's board meeting of the Reserve Bank of Australia (RBA).
The RBA was was widely expected to cut interest rates for the first time in almost seven years on Tuesday, in a bid to loosen tight credit markets and stem a deterioration in business conditions.
Economists expect the RBA to lower the cash rate by 25 basis points from its current 12-year high of 7.25 per cent.
