Chinese stocks led a drop in Asian equities on Wednesday as Beijing's surprise hike of banks' reserve requirements sparked investor concerns that the move could slow the country's purchases of natural resources and other imported goods from Asia.

European share are also expected to extend losses, with futures for the DJ Euro Stoxx falling 0.2 percent.

However, some markets recovered after an initial fall on a growing conviction the policies confirm a broad economic recovery and were targeted at soaking up excess cash from the financial system.

Commodity-linked currencies such as the Australian dollar recovered from their overnight tumble when they reacted to the move by the People's Bank of China late on Tuesday, the strongest step to date by the central bank toward reining in asset price inflation.

The initial perception was China hiking the reserve ratio would impact growth and commodity purchases, but then to think beyond that the impact of the tightening will be very limited in terms of the overall China growth story, said Craig Chan, currency strategist with Nomura Securities.

Bank and property shares in Shanghai yanked the benchmark index <.SSEC> down by 3.1 percent as investors worried gains in stocks of industries, likely to be most affected by policy curbs, would be limited as China steps up its campaign of clamping down on excess cash.

Hong Kong's Hang Seng index <.HSI> dropped 2.4 percent.

But analysts say the fundamental impact on the economy at large and more specifically on corporate balance sheets, would be limited.

Its impact on earnings and economic activity in China will not be material, said Adrian Mowat, Chief Asian and Emerging Market Equity Strategist at JPMorgan.

It is a signal that the economy is strong and the current policy is to reverse pro-growth strategies put in place in response to the credit crunch and synchronized global recession.

IMPROVING SENTIMENT

The MSCI index of Asia Pacific stocks traded outside Japan <.MIAPJ0000PUS> was down 1.4 percent by 0630 GMT after earlier falling 1.6 percent. It had struck a 17-month high on Tuesday on optimism that a global recovery was gaining traction.

Commodity prices skidded with the index of materials stocks <.MIAPJMT00PUS> down nearly 2 percent.

Shanghai aluminum was down 3.4 percent after falling by its 5 percent daily limit and zinc recovered after coming close to its downside threshold. Copper dipped 2.5 percent, having earlier dropped as much as 4.4 percent.

Oil weakened, with NYMEX crude futures down by more than $1 a barrel to below $80 on worries China's move would dampen demand and after an industry group reported an unexpected increase in U.S. distillate inventories.

The yen strengthened on short-covering as investors unwound trades linked to a range of higher-yielding assets.

Japanese government bonds also gained in response to weaker stocks, while U.S. Treasuries surrendered gains after a rally that took cue from weaker shares on Wall Street.

A disappointing start to the U.S. earnings season also weighed on investor sentiment with a profit warning from Chevron following on the heels of poor results from aluminum maker Alcoa . The S&P 500 ended 0.9 percent lower. <.N>

Investors are worried a slowdown in Chinese demand could hit exporters, which faced the brunt of the selling.

China's Vice Minister of Housing and Urban-Rural Development Qi Ji said on Wednesday that property prices in rich coastal cities were excessively high and analysts say Tuesday's tightening measure would not be the last.

Its the first of many such measures to come. I am not surprised, massive excess liquidity, extremely strong growth and inflation which is rising as well. Its definitely the start of a tightening cycle, said Nomura's Chan.

Japan's Nikkei <.N225> fell 1.3 percent, with exporters and resources firms weakened by the stronger yen as China moved to tighten liquidity. Construction equipment maker Komatsu <6301.T>, which has seen Chinese sales soar, fell 2.9 percent.

While China is stepping in to moderate its rapid economic growth, which has buoyed many of its neighbors, many Western countries are still trying to stimulate demand.

Even if it gradually raises interest rates, Beijing's monetary policy is likely to remain loose and pro-growth.

We have had a pretty good start to the year and the markets are retracing a little bit at the moment, said Khiem Do, head of the Asia multi-asset group at Baring Asset Management. It will last for a few days and the market will climb back up again.

Khiem Do said Wednesday's market reflected the volatility that investors can expect this year.

(Editing by Kazunori Takada)

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