North Korea warned it would close the last road link across its increasing tense border with the South if Seoul goes ahead with a threat to broadcast anti-Pyongyang propaganda into its hermit neighbour.

The mounting antagonism has shaken investors, uncertain how far the two Koreas are ready to take their bitter rivalry after the South accused the North of torpedoing on of its warships.

But after a sharp drop in shares and the local currency on Tuesday, Seoul’s financial markets looked stable and the government said it was ready to step in if things looked to be getting out of control.

“The south Korean puppet war-like forces would be well advised to act with discretion, bearing deep in mind that such measures of the KPA (army) will not end in an empty talk,” North Korea’s KCNA news agency quoted a top official as saying.

For a graphic on the ship sinking, click:

http://graphics.thomsonreuters.com/RNGS/2010/MAY/SHIP.jpg

China, which almost single-handedly props up the North Korean government and its destitute economy, again called for calm and dialogue.

Beijing has refused to give its backing to an international investigation that last week concluded North Korea in March sank the South Korean Cheonan corvette, killing 46 sailors.

China is certain to block attempts to impose new sanctions on its ally which means the United States, which strongly backs Seoul’s position over the sinking, may have to accept no more than a carefully worded rap over the knuckles for Pyongyang.

Washington is also looking for ways to avoid the issue collapsing into conflict and it will be at the top of the agenda for visiting U.S. Secretary of State Hillary Clinton, who arrives later in the day from Beijing.

SEVERING TIES

The North on Tuesday announced it was severing all ties with the South, which has announced its own set of measures against Pyongyang for sinking the Cheonan.

Those include resuming, after a six-year lull, the setting up of speakers near the border to broadcast anti-government propaganda and send messages across by balloon.

So far, though, the reclusive state is allowing South Korean workers to enter a joint industrial park that is a lucrative source of income for the Pyongyang government.

The move suggests the isolated North is being careful not to take steps that will cause it real material damage.

But if it does cut the road link to the Kaesong industrial park, it will be unable to function.

Analysts say both Koreas, who have never repeated the open conflict of the 1950-53 Korean War, were unlikely to let their current hostility turn to war.

Apart from Kaesong, there is little economic relationship left between the two, their ties almost frozen since the South’s conservative President Lee Myung-bak took office in 2008.

“North Korea is not closing up Kaesong immediately because it is saving the cards it needs in order to play the game,” said Jang Cheol-hyeon, researcher at the Institute for National Security Strategy.

By paying the workers’ wages directly to Pyongyang, Kaesong is one of the few major legitimate income sources for the North’s secretive leaders, worth tens of millions of dollars a year.

(Additional reporting by Jack Kim, Christine Kim, Jungyoung Park and Choonsik Yoo in Seoul and Arshad Mohammed in Beijing; Editing by Alex Richardson)