Hong Kong shares tumbled 2.6 percent on Friday to their lowest level in over a week as banks came under pressure after the U.S. Federal Reserve raised the discount rate, sparking fears of further monetary tightening.
Investors are bracing for further losses next week, when markets in mainland China reopen after a week-long holiday and get their first chance to react to the latest policy tightening move by the People's Bank of China.
The PBOC's surprise announcement on Feb 12 of an increase in banks' reserve requirements, the second hike this year, weighed on Chinese shares in Hong Kong all week as traders feared a bearish reaction in Shanghai.
Short-selling, which involves selling borrowed shares in the hopes of buying them back when prices fall, rose 8.2 percent from 4.5 percent on Thursday, according to broker estimates.
The benchmark Hang Seng Index .HSI suffered its biggest one-day percentage drop in two weeks on Friday, ending down 528.13 points at 19,894.02, its lowest level since Feb. 10. For the week, the blue-chip index lost nearly 2 percent.
The China Enterprises Index .HSCE of top locally listed mainland Chinese stocks closed down 2.91 percent at 11,263.83..
Market turnover rose to HK$42.89 billion ($5.52 billion) from Thursday's HK$34 billion.
Banking shares led declines after the Fed said it would raise the interest rate it charges banks for emergency loans to 0.75 percent from 0.5 percent, taking a step towards normalising emergency policy used to fight the worst financial crisis since the Great Depression.
Investors largely brushed aside the Fed's assurances that no tightening for the broader U.S. economy, such as a policy rate hike, was on the cards soon.
Hang Seng heavyweight HSBC Holdings (0005.HK), one of the world's leading banks, fell 1.8 percent.
"The market will interpret it (the discount rate hike) as a sign that the Fed is preparing their exit strategy," said Ben Kwong, chief operating officer at KGI Asia. "In that sense, investors will be more cautious. China is already much more obvious -- they've started their tightening measures."
"This is only the beginning," added Steven Lam, vice-president at Karl-Thomson Securities, on the Fed's decision. "Investors may wonder whether the government will now increase the benchmark lending rate. They are more cautious."
Ample supplies of cheap money at near-zero interest rates fueled a stock market rally in Asia in 2009 which saw the Hang Seng surge a blistering 52 percent.
Chinese lenders also succumbed to fears of more policy tightening by Beijing after the long Lunar New year holiday as it clamps down on loans in a bid to keep the economy from overheating. Bank of Communications (3328.HK) and ICBC (1398.HK) slipped 3.8 percent and 3 percent, respectively.
"Investors are worried that the Chinese banks will react to the reserve requirement increase," Kwong said. "They are dumping H shares in preparation for declines in the A share market (next week)."
Underscoring the growing gloom in the market, shares of Chinese health food firm Ruinian International (2010.HK) fell 7.7 percent on their debut as the broader market slump weighed on its HK$900 million ($115.9 million) initial public offering. (Editing by Kim Coghill)