The Australian Industry Group/PricewaterhouseCoopers performance of manufacturing index (PMI) fell 4.2 index points to 47 in June.
The number was below the 50-point level, which separates an expansion from a contraction, for the first time since January.
It also was the weakest reading since November 2005 when the PMI was 43.7.
The survey of about 500 firms was taken in the same month capital city petrol prices hovered above $1.60 a litre.
Crude oil prices hit a record $US143 on the last day of June.
Australian Industry Group chief executive Heather Ridout said higher petrol prices and decade-high interest rates were hurting manufacturers.
"Pressures on manufacturers from factors such as the high dollar and interest rates and the weaker global economy are being compounded on the supply side, by rapid increases in the costs of fuel and other key inputs such as steel and agricultural goods," she said.
The Australian dollar reached a 25-year high of 96.68 US cents on Monday night.
The resources-boom state of Western Australia reported a strong rise in activity, despite the Varanus Island gas plant explosion, but the story was gloomy in the rest of the nation.
Manufacturing activity expanded in just two sectors in June compared with six in May.
"Supported by mining and infrastructure demand, activity grew modestly in the machinery and equipment and fabricated metal products sectors," the report said.
Production, employment and new orders fell sharply in June but inventories stayed firm.
PricewaterhouseCoopers global leader of industrial manufacturing Graeme Billings said the decline in Australian manufacturing activity last month was a sign of slower demand and rising input costs, which were putting significant pressure on profitability.
