Chinese steel and iron ore futures fell sharply on Friday as investors tempered their optimism about demand prospects in the world's biggest steel producer.

Concerns about China cutting its steel production capacity to reduce carbon emissions and easing restocking demand for steel products weighed on sentiment.

The most-traded May contract for iron ore, a key steelmaking ingredient, on the Dalian Commodity Exchange slumped 2.8% to 1,133.50 yuan ($175.11) a tonne by 0330 GMT, after two consecutive days of gains.

Although it hit a record-high of 1,185 yuan a tonne in the previous session, Dalian iron ore slipped 0.7% this week, on track for its first weekly drop in five, given the intensity of Friday's sell-off.

Iron ore's front-month contract on the Singapore Exchange dropped 2% to $168.25 a tonne, but was on course to mark its fourth straight weekly gain.

"Investors have been spooked by China's Ministry of Industry and Information Technology announcement that the country needs to cut steel capacity to meet carbon neutrality measures," said Atilla Widnell, managing director at Navigate Commodities in Singapore.

"On top of that, the seasonal restocking cycle of national steel inventories is drawing to a close, with the growth in stocks slowing this week, meaning that some mills will soon start to moderate capacity utilization rates," he said.

The positive longer-term demand outlook pushed spot iron ore prices in China to multi-year highs on Thursday, with SteelHome consultancy data showing a peak of $179.50 a tonne.