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Lockdown in China as Japan's expats go into hiding

Beijing inflames tensions on anniversary of Manchuria invasion with warning that it may take 'further action' if islands dispute is not resolved

Japanese expatriates in China stayed behind locked doors yesterday, as the anniversary of the incident that sparked Japan's occupation of China prompted more angry demonstrators to pour on to the streets to protest against Tokyo's recent purchase of an archipelago claimed by Beijing.

Shops, restaurants and factories with any ties to Tokyo were closed, as thousands of Chinese demonstrators filled the streets, smashing Japanese-made cars and vandalising sushi bars and other businesses.

Relations between Asia's two biggest economies have deteriorated since Japan's cabinet announced last week that it was purchasing an uninhabited group of islands in the East China Sea – known as the Senkaku in Japan and Diaoyu in China – from a private Japanese owner.

The deal revived deep historical grievances in China, which erupted again yesterday on the 81st anniversary of the Mukden incident, a railway bombing staged by Japan in 1931. The incident was used as a pretext to invade Manchuria, setting off a brutal occupation of China that ended only at the close of the Second World War.

In China's financial capital Shanghai, home to China's biggest Japanese population, thousands of Chinese staged a demonstration outside the Japanese consulate, waving banners saying "Kill all Japanese" and "Destroy all the Japanese dogs". Shanghai's streets had emptied of the city's estimated 56,000 Japanese residents.

At the Japanese embassy in Beijing, protesters threw bottles and fruit and chanted anti-Japanese songs, and demanded boycotts of Japanese goods. Some windows were smashed.

"These people demonstrating are students; they are China's future. They are our national power, ready to burst with patriotic strength," wrote one blogger on the Weibo network. Another, called Bianbianguzhou, wrote: "Thank you Japan for bringing Chinese people together against you, this is something we can cherish."

Beijing has given tacit approval to the protests but there are fears that they could get out of hand. Many of the protesters have carried portraits of Chairman Mao Zedong, which is an implicit criticism of the current administration in China. The Maoist demonstrators bore banners reading: "United, Love China, Never forget our national shame".

All over China, Japanese companies were forced to close. The front page of the Beijing Daily news showed workers at the clothing retailer Uniqlo in the city paint over the company's logo. Uniqlo shut about a quarter of its 145 stores in China for the day.

The disputed islands are surrounded by rich fishing grounds and have strategic importance, but, behind much of the anger, lies a sense of China exercising growing regional clout in the face of what it sees as Japanese nationalism and aggression.

Chinese vessels have been deployed in the waters around the islands, and there was a swift and outraged reaction to news yesterday that two Japanese activists had landed on an island at the centre of the dispute. "The unlawful landing of the Japanese right-wingers on the Chinese territory of the Diaoyu islands was a gravely provocative action violating Chinese territorial sovereignty," said the Chinese foreign ministry spokesman, Hong Lei.

China's defence chief, Liang Guanglie, said he hoped for a peaceful resolution, but warned that the dispute could escalate. "We pay close attention to the development of the issue and we reserve the right to take further actions, but we hope the issue will be properly resolved through peaceful ways and negotiations," he said after talks with US Defence Secretary Leon Panetta.

The archipelago in dispute is made up of tiny rocky outcrops and has been a sore point between China and Japan for decades. Japan has claimed the islands since 1895. The US took jurisdiction after the Second World War and turned them over to Japan in 1972. Last week, the Japanese government bought three of the five islands from the family that owns them, prompting protests in China.

Japan insisted it was trying to head off a potentially more inflammatory move by the governor of Tokyo, who had wanted not only to buy the islands but develop them. But Beijing – and many Chinese – sees the purchase as an affront to its claims and its past calls for negotiations.

While there are fears the tensions could escalate into a more serious conflict, the initial fallout looks likely to be felt on trade between Asia's two biggest economies. China is Japan's largest trading partner, and Japan is China's third largest.

There are regular outbursts of anti-Japanese sentiment in China but this is the worst since 2005, when riots took place over a history book the Chinese felt downplayed Japanese atrocities in China during the war. Although tensions are running high, few expect they will result in armed conflict.

Trading partners: The economic fallout

China and Japan are the world's second and third largest economies, and despite deep historical grievances, business links are thriving.

Trade between the two countries totalled nearly $345bn (£212m) in 2011, a 14 per cent rise from the previous year and a record figure for the rivals. About 140,000 Japanese expatriates live and work in China.

Then there is Japanese investment in China's ever-expanding transport network, with the transfer of high-speed train technology helping to slash journey times between China's cities. And it's not just businesses building bridges between the nations – tourism is flourishing too. Only South Koreans visit Japan in greater numbers than Chinese tourists. China, meanwhile, is the most popular holiday destination for Japanese tourists,

But as tensions mount over the islands, tour operators are already reporting a drop in bookings and some cancellations. The Japanese carrier All Nippon Airways has had 18,800 seat reservations cancelled since the anti-Japanese protests flared up, The Wall Street Journal reported.