"Bird flu is having a psychological impact on investors," said Alfred Chan, chief dealer at Cheer Pearl Investment Ltd.
The blue chip Hang Seng Index ended 85.50 points lower at 14,402.35. Volume was slightly below recent averages with HK$16.2 billion ($2.07 billion) worth of shares exchanged.
Dealers said the Hang Seng had support at the 250-day moving average near 14,160, but could test that during the coming week.
Retail and hotel shares such as Regal Hotels fell sharply on growing concern that the avian flu could spread into a widespread epidemic, halting travel and tourism in the region. Regal, which owns hotels in Hong Kong and Shanghai, fell 12.64 percent to HK$0.47.
Cosmetic retailer Sa Sa International Holdings Ltd, which caters largely to mainland China tourists, fell 7.32 percent to HK$2.85, its lowest level in more than a year.
China's vice minister of health, Huang Jiefu, was quoted by the South China Morning Post on Saturday as saying any human case would be quarantined and that China would close its borders, including with Hong Kong, if there were a single case of human-to-human transmission of the H5N1 virus.
China has reported several cases of the deadly virus in wild birds and domestic fowl over the last year but no human cases.
The virus has killed over 60 people in Asia in the past three years and health experts fear it could kill millions world-wide if it mutates into a form that can pass easily from person to person.
Trade was also cautious ahead of a slew of US corporate earnings and the expiry of futures contracts later in the week.
"Investors are a bit jittery ahead of corporate earnings for fear of more volatility in the markets. Also the expiry of futures contracts later this week will add volatility," said Louis Wong, research director at Phillip Securities.
Big US firms ranging from Texas Instruments to Microsoft and drug maker Merck & Co are due to report third quarter earnings this week amid concerns that high oil prices may crimp consumer demand and corporate profits.
The US Federal Reserve is due to meet early next week to set interest rates among growing expectations that rates will continue to rise to combat surging inflation.
Interest rate-sensitive property stocks were lower with worries about further rate increases adding to fresh data showing new home sales are waning in the second half of the year.
Property sales, a key pillar of Hong Kong's service driven economy, have risen 11 percent so far this year, but sales have slowed significantly since the first quarter, according to data from local property agency Centaline Property Agency.
The city's top developer, Sun Hung Kai Properties Ltd, fell 0.6 percent to HK$74.30.
Top blue chip performers included exporters Li & Fung and Co Ltd and Johnson Electric Holdings Ltd, which benefited from a rising US dollar, which was trading at near-two year highs versus the Japanese yen.
Sourcing and trading firm Li & Fung rose 0.6 percent to HK$16.65, while mini-motor maker Johnson Electric rose 0.7 percent to HK$7.10.
China enterprise stocks ended lower with airline shares hurt by bird flu worries. China Eastern Airlines Corp Ltd fell 4.67 percent to HK$1.02, its lowest level in about two years.
Shipping shares were hurt by continued signs that container freight rates were falling due to expanding capacity amid weakening demand.
China COSCO Holdings fell 2.22 percent to HK$3.30.
But Angang New Steel Company Ltd rose 6.2 percent to HK$4.27 after its parent firm offered compensation worth 779.33 million yuan ($96 million) on Friday to domestic investors worried about an overhang of state-owned shares.