By Nathaniel Taplin
SHANGHAI (Reuters) - China shares dived on Monday in volatile trade as fears of a regulatory crackdown on the world's hottest stock market offset the central bank's most aggressive move yet to bolster the slowing economy.
A cut in banks' reserve requirements announced by the People's Bank of China on Sunday was the largest since the global financial crisis, but markets reacted half-heartedly as traders focused on moves by the securities regulator which they feared could pop a gravity-defying, six-month rally.
Money market rates fell but corporate bond yields were largely flat, while the yuan > weakened about 0.9 percent to 6.203 to the dollar by late afternoon.
Stocks had rallied early and at one point touched fresh seven-year highs, with the CSI300 <.CSI300> of the largest listed companies in Shanghai and Shenzhen closing the morning session up 1.2 percent.
But those gains quickly evaporated in the afternoon on concerns that regulators want to slow the pace of gains in a market that has already bolted more than 80 percent since late November, thanks in large part to borrowed money.
Securities regulators announced on Friday they would allow fund managers to lend shares for short-selling, and ban margin financing through unregulated accounts. [ID:nL4N0XE37W]
"The government wants a slow bull market, not a crazy bull," said Wang Yu, an analyst at Pacific Securities.
Both the CSI300 index <.CSI300> and the Shanghai Composite Index <.SSEC>, which tracks all stocks on the Shanghai Stock Exchange, ended down 1.6 percent.
Zhang Yunyi, general manager of Shanghai-based hedge fund manager Hongyi Investment, expects the market to consolidate for about two months, after climbing seven weeks straight on hopes that Beijing would pump in more stimulus to lessen the risk of a sharp slowdown in the world's second-largest economy.
Economists are unsure how much of the estimated 1 trillion yuan ($161.2 billion) in cash freed up by the latest 100 basis point reserve cut will find its way into new bank loans and real economic activity, with many suspecting a fair chunk will flow into stocks given their far superior returns to other investments at present.
Still, some analysts believe the RRR cut was partly designed to cushion the risk of a sharp blow to markets from the securities regulator's latest ruling.
"The decision to lower the RRR now may also have been influenced by concerns about the impact on the stock market of policy changes announced on Friday," Mark Williams, the chief Asia economist at Capital Economics said in a note.
"After a sharp sell-off in futures contracts, the regular later issued a statement that the market 'should not over-interpret the measures'. The result of the RRR cut is almost certain to be a further large run-up in share prices."
Markets had widely expected imminent action following March data last week which showed money supply growth and industrial activity at multi-year lows, with the latter posting its worst year-on-year performance since the financial crisis. But the latest cut was more bigger than expected.
The reduction in the reserve ratio, now at 18.5 percent, follows another cut in February and two interest rate cuts since November 2014, the first of the which ignited the latest stock market rally.
More policy easing is expected if business conditions continue to deteriorate, with Beijing looking to defend an economic growth target of around 7 percent this year, which would be the slowest in a quarter of a century.
Policymakers have struggled, however, to bring down real borrowing rates which remain stubbornly high for many firms, as reflected by continuing high bond yields.
Short-term rates fell and interest rate swap yields declined on Monday. But spreads between high and low-rated debt barely moved, suggesting that market participants do not anticipate fresh funds will flow to the firms that need them most.
Analysts said the RRR cut, which releases more funds held by banks for lending, also was partly aimed at lowering bond yields ahead of a massive planned expansion in municipal bond issuance by debt-laden local governments this year.
"Despite the interest rate cut in March, the yield curve still moved up recently, especially on the long end," wrote the Morgan Stanley China Economics team headed by Helen Qiao in a note on Sunday.
"We believe further monetary easing will help lower funding costs, which is very much needed. In addition, it could support upcoming local government bond issuance with a lower yield."
($1 = 6.2012 Chinese yuan)
(Additional reporting by Pete Sweeney and Samual Shen; Editing by Kim Coghill)
