Mainland stocks fell, erasing earlier gains, on speculation the China's central bank will accelerate increases in interest rates after boosting borrowing costs over the weekend. Bonds dropped and yuan forwards climbed.

The benchmark Shanghai Composite Index declined 1.9 percent to 2781.40 at the close on Monday, the lowest since Oct 8. Commodity and consumer companies ranging from Aluminum Corp of China Ltd to Kweichow Moutai Co slid more than 2 percent on concern that monetary tightening will slow economic growth. Chinese currency forwards rose to a five-month high on prospects the government will allow further currency gains to contain consumer prices that reached a 28-month high in November.

"Investors were initially relieved as this interest-rate increase had been priced into stocks for a long time," said Dai Ming, a fund manager at Shanghai Kingsun Investment Management & Consulting Co. "However they're now thinking about the future; that one increase won't be enough to bring inflation under control and more rate hikes will be needed. That will keep depressing valuations of stocks."

The People's Bank of China increased key one-year lending and deposit rates by 25 basis points on Christmas Day in its second move since mid-October. The benchmark lending rate rose to 5.81 percent, compared with 7.47 percent before cuts from late 2008 to counter the global financial crisis. The deposit rate increased to 2.75 percent, compared with the 5.1 percent annual pace of inflation in November, the highest in 28 months.

Premier Wen Jiabao's government aims to limit asset bubbles in the real-estate market and prevent rising prices from leading to social problems after pumping large amounts of liquidity into the economy from late 2008 to drive a recovery.

Rate outlook

China's monetary tightening in 2011 may be mainly in the first half, JPMorgan Chase & Co and Morgan Stanley said. China may raise rates as many as three times in the first half of next year, according to Morgan Stanley, while JPMorgan forecasts two increases in that period.

The Shanghai Composite rose as much as 1.5 percent before slumping in the last hour of trade. Aluminum Corp of China and Zhuzhou Smelter Group Co, the nation's biggest producers of aluminum and zinc, slid more than 2 percent. Kweichow Moutai, a spirits maker, and GD Midea Holding Co, a manufacturer of home appliances, dropped more than 3 percent.

The central bank raised rates for the first time since 2007 in October, and on Dec 10 ordered lenders to set aside more money as reserves for the third time in five weeks. The policy tightening has contributed to a 15 percent decline in the Shanghai Composite this year, the biggest drop among the world's 15 largest equity markets, including a 2 percent loss last week.