China's monetary tightening and disappointing corporate earnings put downward pressure on world stocks on Wednesday, combining to present investors with two of their biggest concerns.

The dollar steadied. European shares gained, primarily due to demand for defensive stocks.

Heading into the new year, investors have been concerned about the impact on markets from the eventual withdrawal of liquidity in major economies.

China in effect tightened monetary policy on Tuesday by raising banks' reserve requirements, with an eye toward reining in surging asset prices.

At the same time investors are seeking confirmation that improvements in economies and corporate profits are sustainable.

So far in this earnings season, U.S. aluminum giant Alcoa has disappointed while oil firm Chevron issued a profits warning. In Europe, French bank Societe Generale said on Wednesday it was expecting only a slight profit for the fourth quarter of 2009.

MSCI's all-country world stock index <.MIWD00000PUS> was down 0.4 percent with its emerging counterpart <.MSCIEF> losing 1.1 percent.

Japan's Nikkei <.N225> earlier lost 1.1 percent.

Confidence is dissipating quickly. There is a concern that with such a low level of volume we are setting ourselves up for a correction, said Justin Urquhart Stewart, director at Seven Investment Management.

Despite this, Europe's FTSEurofirst 300 <.FTEU3> reversed earlier losses and was gaining about 0.2 percent on the back of defensive sector demand.

DOLLAR STRONGER

The dollar was steady while the yen fell broadly, with the market concluding China's move would not derail growth but still rattled by the idea of liquidity withdrawal.

It prompted investors to unwind positions against currencies such as the commodity-linked Australian dollar.

While the move itself was a minor step, it's significant going forward as China is likely to be more aggressive tightening policy, where the near-term impact will be more downside risks to the 'riskier' currencies, said Lee Hardman, currency economist at Bank of Tokyo-Mitsubishi UF.

The dollar was up slightly against a basket of major currencies <.DXY>. The euro slipped to $1.4483, while the dollar gained a third of a percent to 91.24 Japanese yen.

Euro zone government bonds were mixed ahead of a heavy round of new issuance including new bonds from Germany and Italy.

(Additional reporting by Joanne Frearson and Tamawa Desai; editing by John Stonestreet)

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