China's stocks were lower on Monday as Beijing's latest tariff threats escalated the tit-for-tat Sino-US trade war, though the central bank's efforts to shore up the tumbling yuan helped to stabilise the currency.

At the midday break, both the Shanghai Composite index and the blue-chip CSI300 index were down 0.8 per cent, erasing earlier gains. Shares in Hong Kong trimmed earlier gains, with the Hang Seng index adding 0.7 per cent. The China Enterprises index gained 0.3 per cent.

The volatility in Chinese markets on Monday comes after the Shanghai and Hong Kong indexes had suffered their biggest losses since February last week, weighed by a combination of weak economic data and concerns over the growth impact from the trade war.

“The pressure on China's economic growth will be relatively heavy amid the trade frictions with the United States, and risk appetite could continue to sour,” said Yang Weixiao, an analyst with Founder Securities in Beijing.

Considering still-tight liquidity, the benchmark Shanghai Composite index could fall below 2,638 points, seen as a key psychological level since early 2016, he said.

“The 'national team' could offer some support by buying heavyweight stocks, as they did in late trading sessions in the past days, though the impact would be rather limited,” Yang said, referring to a band of government-backed investors who have been ordered to buy stocks during previous market slumps to support share valuations.

China proposes retaliatory tariffs

China had fired the latest volley in the trade war on Friday, proposing differentiated retaliatory tariffs on $60 billion worth of US goods ranging from liquefied natural gas (LNG) to some aircraft. The move followed a proposal by the Trump administration of higher 25 per cent tariffs on $200 billion worth of Chinese imports to the United States.

Also on Friday, China's central bank had said it will be setting a reserve requirement ratio of 20 per cent from Monday for financial institutions settling foreign exchange forward dollar sales to clients, effectively raising the cost for investors shorting the yuan.

On Monday, the state-run China Daily sought to strike a reassuring tone, saying market participants expected a stable yuan, solid growth and were not worried about the impact of the US-China trade dispute.

The onshore yuan opened at 6.8200 per dollar and was changing hands at 6.8260 as of 0405 GMT, 28 pips stronger than the previous late session close of 6.8288. On Monday, the central bank set the yuan's daily midpoint at 6.8513 per dollar, its weakest level since May 31, 2017, but largely matching forecasts.

Traders said some dollar selling from their clients emerged in early trade Monday to push the yuan higher, but the gains were quickly eclipsed by heavier dollar buying. A trader at a Chinese bank said the market believed the latest measures by the central bank were not meant to reverse the depreciation in the yuan, but to control the pace of losses.

Tommy Xie, an economist at OCBC Bank in Singapore, said the move by the PBOC was “not a game changer” but was a strong signal to markets that it was not comfortable with the pace of depreciation.

“Looking back in 2015, the implementation of reserve requirements helped stop the panic sale of RMB for a short period,” he said. “However, it did not stop RMB from weakening further later due to weak sentiment weighed down by the consecutive decline of China's FX reserves.”

A trader at a Chinese bank in Shanghai said the move to introduce reserve requirements would increase the cost of buying one-year dollar forwards by 400-500 pips per dollar.

Xie added that if market volatility remained high, the PBOC could choose to roll out its counter-cyclical factor, a tool introduced in May in 2017, and paused in January, to reduce price swings and counteract yuan weakness.

He said the PBOC may try to gauge the market reaction to the reintroduction of reserve requirements to determine if the counter-cyclical factor is necessary.

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