BEIJING—As the past trading week drew to a close, the People’s Bank of China was getting increasingly nervous about the money evaporating from Chinese stocks.

The central bank decided it was time for an about-face, quickly moving to ease credit.

Just a week or so earlier, China’s central bank had quietly drained some funds from the country’s financial system, another step in the dance between the PBOC and investors. Its objective, according to banking executives and officials close to the central bank: to take some heat out of the country’s feverish stock market by preventing banks flush with cash from funneling money into stocks.

But the effort had gone awry, sending a signal to investors that Beijing’s recent easing cycle was coming to an end. Chinese equities plunged in the following days, culminating in Friday’s 7.4% decline, their biggest one-day drop in years. Panic selling even spilled over to the government-bond market.

Chinese markets fell in early trading Monday, and markets across Asia also opened lower on volatility in Greece.

At the central bank, officials scrambled for an action plan in late-night discussions Friday, people close to the bank say, followed by meetings with the nation’s top financial regulators early Saturday.

To stave off a widespread meltdown, these people say, the PBOC decided the situation required a strong gesture—one that was quickly approved by the State Council, China’s cabinet. On Saturday, the central bank announced a quarter-point interest-rate cut coupled with the loosening of some banks’ reserve requirements—a rare combo move not seen since 2008, at the height of the global financial crisis.

The Chinese gyrations underlined not just investors’ dependency on signals from a central bank that often fails to clarify its intentions but also how hard it is for China’s leaders to steer credit where they see it as most needed: at companies trying to keep their heads above water.

Much of the freed-up cash from all the recent easing—Saturday’s interest-rate cut was the fourth since November—has instead gone to fuel the stock-market frenzy, while growth in the world’s second-largest economy remains anemic.

Both exports and imports shrank last month, and crucial growth drivers such as factory output and property markets continue to drag. On Sunday, senior Chinese officials including Finance Minister Lou Jiwei and the country’s top auditor, Liu Jiayi, both sounded alarms about the economy’s ability to meet Beijing’s 7% growth target for this year, according to the official Xinhua News Agency.

The interplay between the PBOC and the stock market started late last year. Stocks began to rise partly in response to moves by the central bank to ease credit, with investors increasingly looking for signals for more efforts to spur growth.

But some analysts saw the bank’s easing action Saturday as giving in to investor demand, pointing to risks of a vicious cycle, in which Chinese investors and the central bank become dangerously beholden to each other.

With Saturday’s action, China’s monetary policy risks “getting kidnapped” by the stock market, said Zhong Zhengsheng, director of economic research at Hua Chuang Securities, a state-owned brokerage.

“Using monetary easing to support the stock market is highly debatable,” said Haibin Zhu, China economist at J.P. Morgan Chase & Co.

The press office of the People’s Bank of China didn’t respond to a question of whether the actions were related to the stock-market drop. But some officials at the PBOC, known as Yang Ma, or Big Mama, in China, say the bank had to respond to the severe market fall as maintaining the country’s financial stability is part of its job.

In remarks posted on the Chinese government’s website Sunday, Lu Lei, head of research at the PBOC, said the latest action was intended to “stabilize growth” amid continued downward pressure on the economy.

By LINGLING WEI on June 28 2015 in The Wall Street Journal