* SSEC -1.0% pct, CSI300 -1.3% pct
* Yuan weakens sharply, offshore yuan at lowest level since Dec
* Beijing says it will not yield on matters of principle
* China unlikely to use depreciation
By Winni Zhou and Andrew Galbraith
SHANGHAI, May 13 (Reuters) - Chinese shares fell on Monday and the yuan weakened to a four-month low as investors’ hopes for a deal to end an escalating trade war between the United States and China were dashed.
The benchmark Shanghai Composite index was 1% lower at the midday break and the blue-chip CSI300 index lost 1.3%, resuming the previous week’s downward slide.
While they recorded sharp losses for the whole of last week, both indexes had surged more than 3% on Friday, lifted by hopes that the continuation of talks could bring an agreement between Beijing and Washington, despite President Donald Trump hiking tariffs on $200 billion worth of Chinese goods.
But those hopes ebbed on Monday as Beijing and Washington appeared to be at an impasse, as Washington demanded promises of concrete changes to Chinese law and Beijing said it would not swallow any “bitter fruit” that harmed its interests.
With no signs of a quick solution in sight, investors continued to await Beijing’s response to the higher tariffs. China has said it would adopt countermeasures, but has not yet spelled out what it will do.
Investors are closely watching to see how Chinese policymakers plan to offset the impact of the stiffer tariffs on both the economy and financial markets, analysts at Citi said in a note, adding that Beijing’s options include support for stock markets and the yuan, as well as monetary policy measures and liquidity injections.
The smaller Shenzhen index was down 0.9% and the start-up board ChiNext Composite index was weaker by 1.66%.
Markets in Hong Kong wee closed Monday for a public holiday.
Worries over the trade impasse also hit China’s currency, which was dragged lower by heavy corporate demand for the greenback.
Prior to the market open, the People’s Bank of China (PBOC) lowered the official midpoint of the yuan’s daily trading band to 6.7954 per dollar. That was 42 pips, or 0.06 percent, weaker than the previous fix of 6.7912 on Friday and the softest since Jan. 23.
Still, traders said Monday’s official fixing was much higher than market expectations, following a similar surprise last week. The midpoint was 95 pips firmer than Reuters’ estimate of 6.8049.
In the spot market, onshore yuan opened at 6.8459 per dollar and was changing hands at 6.8566 at midday, 366 pips away from the previous late session close.
“Many market participants had hoped that Trump’s tariff hike threats were just his negotiation tactics last week. But now tariffs are higher,” said a trader at a Chinese bank, noting that the talks appeared stalemated.
Selling pressure on the yuan was heavy in the morning, several traders said, as many corporate clients showed rising interest to load up on dollars.
Companies that were debating whether to liquidate their long dollar positions last week were unwilling to sell dollars, awaiting better prices, they said.
In the past, major state-owned Chinese banks have usually sold dollars to prop up a falling yuan. On Monday, traders said they did not see signs of such state bank action.
Since the trade dispute blew up last week, some market watchers now believe the yuan is at risk of breaching the psychologically-important 7 to the dollar mark, which it avoided last year.
But while Beijing has not yet outlined its response to higher U.S. tariffs, Tommy Xie, head of Greater China research at OCBC Bank in Singapore, said it was unlikely the country would use its currency as a trade war weapon.
“We think China is unlikely to engineer 25% depreciation to counter the impact of tariff as the cost of capital outflows amid the shrinking current account surplus may outweigh the benefit of supporting export,” Xie said in a note.
“The pressure on RMB depreciation may depend on three near-term factors including the size of China’s retaliation package, U.S.’s plan to impose tariff on the remaining $325 billion products and market’s assessment on whether the setback is temporary or not,” he added.
Offshore yuan eased to a low of 6.8965 at one point in the morning, its weakest level since Dec. 27. It was trading at 6.8896 per dollar at midday.
Reporting by Winni Zhou and Andrew Galbraith; Editing by Richard Borsuk