Shares in Shanghai and Hong Kong fell on Monday as investors played safe and pared long positions on fears that Beijing will take more aggressive measures to contain inflation. Banking shares and resource stocks were among the biggest losers in both centres on concerns that further interest rate increases in China will cool its robust economic growth.
China's key stock index fell 0.7 percent, weighing on the China Enterprises Index, an index of Hong Kong-listed Chinese companies, which slipped 1.1 percent.
Hong Kong's Hang Seng index fell for a third successive day, easing 0.3 percent to 23,801.8 points.
The Hang Seng has lost 2.5 percent after hitting a high for the month of 24,420 last week. Turnover was the lowest in three weeks, suggesting investors remained wary but not overly bearish.
"Inflation pressures in China are very, very high and are not restricted only to food," said Larry Jiang, chief investment strategist at Guotai Junan Securities in Hong Kong, adding that the good start to the year had raised expectations that the Hang Seng would rise above its 2010 high of around 25,000.
"When that didn't work out, I think people were disappointed. Some foreign investors who got into Hong Kong late probably feel that the pace of tightening is going to get quicker," said Jiang.
Cyclicals, in particular the materials sector, have been hit by profit-taking after getting off to a strong start to the year on hopes that a recovery in the global economy would boost demand for resources.
The sector sub-index ended the day down 2 percent. Aluminum producer Chalco fell 1.8 percent, while China Zhongwang Holdings slumped 6.2 percent after warning that profits for 2010 would decline by more than 25 percent.
Shipping company China Merchants Holdings fell 2.8 percent, extending last week's 3.1 percent drop.
Lingering worries over more monetary tightening, including fears of an imminent rate hike, have kept mainland markets under pressure, with the benchmark continuing to underperform most of its Asian peers.
The Shanghai Composite Index ended at 2,695.7 points, extending last week's 2.7 percent. It is now trying to find a support above the 2,655-2,677 gap it created in early last October, analyst said.
"Expectation of further tightening hurt investors' confidence," said Wang Aochao, a senior analyst at UOB Kay Hian in Shanghai. "We think the index still has room to fall."
Keeping investors edgy was a report in official newspaper Securities Times that cited analysts at securities firms saying the week before and after the Lunar New Year was the most sensitive period when the central bank could announce another rate hike.
Chinese markets will be shut next week for the Lunar New Year holidays.
Most of banks listed on the Shanghai and Shenzhen stock exchange underperformed the index on Monday, with Construction Bank dropping 1.1 percent and Agricultural Bank of China down 1.2 percent.
Industrial and Commercial Bank of China (ICBC), the world's largest lender by market capitalisation, fell 0.7 percent after it said it would buy Bank of East Asia's US unit.
Small cap stocks, which had significantly outperformed the broader market in Shanghai last year, also retreated on fears that valuations had run ahead of potential earnings growth.
The small-caps index dropped 2.4 percent to its lowest level since late August. It gained 10.1 percent in 2010 compared with the Shanghai Composite's 14 percent decline. Yunnan Chihong Zinc & Germanium, dropped 8.3 percent, while Hubei Yihua Chemical Industry fell 6.7 percent.
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