July 29 (Bloomberg) -- Chinese stocks plunged the most in eight months, dragging emerging markets lower, on speculation the government will curb investment to prevent a bubble. Oil led a drop in commodities.

The Shanghai Composite Index fell 5 percent, its biggest decline since Nov. 18, snapping a five-day, 7 percent advance. The MSCI Emerging Markets Index sank 1.6 percent to 823.04 at 3:12 p.m. in London, the biggest decline since July 6. Oil and copper fell the most in three weeks. The dollar rose as investors shunned higher-yielding currencies.

“Speculation the central bank may take steps to rein in liquidity worried the market,” said Gabriel Gondard, deputy chief investment officer at Fortune SGAM Fund Management Co., which oversees about $7.2 billion in assets. “A lot of people were looking to take profits” in China, he said.

Chinese stocks are trading at 35.3 times reported earnings, more than twice the average in emerging markets, after a 79 percent surge in the Shanghai index this year on prospects for a global economic rebound. Federal Reserve Bank of San Francisco President Janet Yellen said yesterday the U.S. economy’s recovery is likely to be “painfully slow” as consumers spend less and save more.

China Construction Bank Corp. will cap full-year loan growth at about 900 billion yuan ($131.8 billion) this year, Beijing’s Caijing magazine reported yesterday, after loans grew 709 billion yuan in the first half.

‘More Volatility’

“After such a good run, there is the temptation for people to get off the rollercoaster,” Brian Jackson, senior strategist at RBC Capital Markets in Hong Kong, said in an interview. “We are going to see more uncertainty and volatility.”

Russia’s ruble fell 1.3 percent against the dollar, the second biggest loser among 26 emerging-market currencies tracked by Bloomberg behind The Colombian Peso which dropped 1.87 percent. Kazakhstan’s eight-stock KASE index dropped 1.3 percent, led by a 4percent slide in Kazakhmys Plc, the central Asian nation’s biggest copper producer.

Europe’s Dow Jones Stoxx 600 Index climbed 1.1 percent as earnings from Akzo Nobel NV and Bayer AG beat analysts’ estimates, outweighing declining commodities and a wider-than- estimated loss at ArcelorMittal SA. Akzo Nobel, the world’s largest maker of coatings and paints, and Bayer, which supplies plastics to the auto industry, advanced more than 5 percent.

European Credit

European banks tightened credit standards for companies and households less aggressively in the second quarter, down to a net 21 percent of lenders from 43 percent in the first quarter, the European Central Bank said in its bank-lending survey. The worst recession since World War II has made banks reluctant to lend and eroded company and household demand for credit.

The MSCI Asia Pacific Index declined 1 percent after reaching the most expensive relative to the earnings of its companies in six years. Jiangxi Copper Co. slumped 9 percent in Shanghai after forecasting a drop in profit.

The Standard & Poor’s 500 Index retreated 0.4 percent, paring an earlier decline as consumer companies rallied. Orders for U.S. durable goods, excluding automobiles and aircraft, unexpectedly rose in June. Demand climbed 1.1 percent, the most in four months, signaling manufacturing may expand in the second half of the year.

The yen and the dollar advanced most against the currencies of commodity-producing countries such as Australia and South Africa. The Aussie dropped 0.4 percent against the yen and 0.8 percent compared with the U.S. dollar, the largest declines in three weeks. The rand slid 0.2 percent against the U.S. currency.

Oil Stockpiles

“The flight to quality triggered demand for the dollar,” Kenneth Broux, an economist at Lloyds Banking Group in London, wrote in a report today. That “removed a prop for emerging markets and the Australian and Canadian dollars, two of the best-performing Group of 10 currencies that correlate positively with stocks.”

Oil dropped 3.1 percent to $65.12 a barrel in New York. U.S. crude stockpiles rose the most since April last week, the American Petroleum Institute said yesterday. Copper for September delivery fell 1.8 percent to $2.476 a pound in New York on concern Chinese imports are slowing.

Chinese Premier Wen Jiabao’s 4 trillion yuan ($585 billion) stimulus package last year and looser credit restrictions spurred a surge in domestic demand and record bank lending as the global recession led to a slump in exports.

The extra yield investors demand to own developing nations’ bonds instead of U.S. Treasuries rose 9 basis points to 3.91 percentage points, the highest in a week, according to JPMorgan Chase & Co.’s EMBI+ Index.

To contact the reporter on this story: Laura Cochrane in London at lcochrane3@bloomberg.net

Last Updated: July 29, 2009 10:25 EDT