SHANGHAI, Aug 31 (Reuters) - China stocks recovered most of their early losses by midday on Friday, as trade war fears were offset by a surprise pick up in Chinese factory activity and hopes for fresh foreign money inflows ahead of the second leg of the MSCI inclusion.
The blue-chip CSI300 index fell as much as 1.2 percent in morning trade, but by midday was down just 0.2 percent at 3,344.28 points.
The Shanghai Composite Index lost 0.1 percent to 2,735.51 points.
In Hong Kong, the benchmark index was led lower by index heavyweight Tencent, as the Chinese government's tougher measures against online gaming affected game operators.
The Hang Seng index dropped 1.1 percent, to 27,860.47 points, while the Hong Kong China Enterprises Index lost 0.8 percent, to 10,875.14.
The markets opened lower after a report that U.S. President Donald Trump is prepared to ramp up a trade war with China and is ready to impose tariffs on $200 billion more in Chinese imports after a period of public comment on the plan ends next week.
Some mainland investors took advantage of the dip and snapped up bargains, pushing banks and other blue-chips higher.
Big-caps are expected to benefit from the second tranche of China's MSCI inclusion on Sept. 3, that could see some passive overseas funds buying Chinese stocks in the final hour of trading on Friday to avoid index tracking errors.
Also helping sentiment was fresh data showing growth in China's manufacturing sector had unexpectedly picked up in August after a two-month slide, offering some cushion for a slowing economy as China-U.S. trade tensions heat up.
"China's stock market has priced in a very bad situation as if the Chinese economy was going into a hard landing, which I don't think will be the case," said Chi Lo, economist at BNP Paribas Asset Management.
Gaming companies led the IT sectors in China and Hong Kong sharply lower, after the Chinese government proposed that more steps be taken to control online video games. Shares in Tencent Holdings slid more than 5 percent in Hong Kong, wiping a further $20 billion from the company's market value. Gaming firms on the mainland also fell, including YOUZU Interactive, Ourpalm and Tangel Publishing.
(Reporting by Shanghai Newsroom Editing by Darren Schuettler)