The sharemarket suffered its sharpest one-day fall for two months yesterday after the US Federal Reserve said it could reduce its economic stimulus measures and China's manufacturing showed signs of contraction.
"In the next few meetings we could take a step down" on bond purchases, Fed chairman Ben Bernanke said, and the minutes of the recent Federal Open Market Committee meeting showed "a number of participants expressed willingness to adjust the flow of purchases downward".
HSBC's flash China manufacturing purchasing managers index hit a seven-month low of 49.6 in June from 50.4 in May, raising questions about the extent of China's demand for resources.
The benchmark S&P/ASX 200 closed down 2 per cent at 5062.4, near a four-week low of 5058.6, and the trading volume rose to $7.1 billion, from $5.1bn on Wednesday.
Offshore selling dominated as the Australian dollar dived to a fresh 12-month low.
"Feedback is that it will take a month or two to flush out the offshore investors and during that period of time the market could fall 300-400 points," said BBY institutional dealer Anson Rosewall.
High-yield stocks were among the worst affected by the prospect of rising US bond yields as the market anticipated a tapering off of the Fed's bond purchases.
Big banks fell between 2.8 per cent to 4.1 per cent, Telstra lost 3.7 per cent, Sydney Airports dived 3.7 per cent, toll-road operator Transurban lost 3.6 per cent and utility SP AusNet fell 6.2 per cent.
Property trusts remained weak, with Goodman, Stockland, GPT and Mirvac down between 2.9 per cent to 4.2 per cent.
Among resources stocks, BHP Billiton, Rio Tinto, Newcrest and Fortescue Metals fell between 1.1 per cent to 2.8 per cent after HSBC's China manufacturing data disappointed the market.
"The cooling manufacturing activities in May reflected slower domestic demand and ongoing external headwinds," HSBC economist Qu Hongbin said in a statement.
"The further signs of labour market slackness call for more policy support. Beijing still has fiscal ammunition to do so," Mr Qu added.
Non-resources offshore-income earners including News Corporation, QBE Insurance, Brambles and Amcor rose between 0.8-6.6 per cent due to the US dollar's strength.
News of weaker Chinese manufacturing data for May also eroded support for the dollar, sending it to fresh 11-month lows.
At 5pm AEST, the dollar was buying US96.23c, down 1.59c.
The currency has fallen by more than 7 per cent against the greenback since the start of the month.
Rising expectations that the Fed is nudging toward some form of stimulus withdrawal, a cut in local interest rates to record lows, and signs that Australia's mining investment boom has peaked, have combined to weaken the currency.
