Acting fast: A euro symbol sculpture is seen at the ECB headquarters in Frankfurt, Germany. The bank is expected to deliver a second interest rate cut before the Fed even gets going soon. — Bloomberg
WHILE there has been a lot of talk about the West’s strategic decoupling from China’s sputtering economy, Europe’s direct trade links with Beijing have actually been deepening.
This difference may help to explain some of the divergence in monetary easing between the Federal Reserve (Fed) and the European Central Bank (ECB).
The latter is expected to deliver a second interest rate cut before the Fed even gets going soon and will likely move a third time in October.
If China’s economy keeps stumbling, this divergence between the Fed and the ECB could grow.
Worries continue to mount about the state of the world’s second-biggest economy. China keeps slowing despite Beijing’s multiple efforts to stimulate domestic demand, the country’s property bust shows no signs of letting up, consumer and producer price deflation lurks, and trade tensions are mounting.
The potential drag on the global economy from China’s slowdown was a concern raised by central bankers gathered at the Fed’s Jackson Hole symposium recently.
And then last week investment bank UBS cut its 2025 China growth forecast to just 4% – far below Beijing’s 5% target and the 5.1% forecast by the International Monetary Fund. While China’s weakness will obviously affect both the United States and Europe, the latter seems to be in much bigger trouble.
The Peterson Institute for International Economics (PIIE), a Washington-based think tank, last week crunched the latest customs-cleared data through last year and highlighted the extent of this divergence.
The PIIE report showed that while the United States reduced its dependency on Chinese imports sharply in the five years through 2023, the share of European Union (EU) imports originating in China has actually grown.
The deepening trade links between China and the EU are even more pronounced when zeroing in on manufactured goods. While China relies on the United States for less than 10% of its manufactured imports, it purchases more EU goods than it did five years ago.
The EU’s strong ties with China are further underscored by the fact that the yuan accounts for more than 18% of the euro’s trade-weighted index, about five percentage points more than its share in the dollar’s equivalent.
PIIE authors Mary Lovely and Jing Yan offered a “geo-economic” take on these trends.
“Despite efforts by the Biden administration to convince the EU to wean itself off Chinese imports, the opposite is happening. Europe has grown more dependent on China in recent years as the United States has become less so,” they wrote.
“This increasing divergence in US and European economic interests may make it harder for them to agree in the future on national security and technology policies involving Chinese imports.”
But for most investors the takeaway may be a lot simpler: Europe’s relative economic exposure to China is still massive and has serious implications for growth, inflation, and, by extension, central bank policy.
This data set covers a pivotal period in US-China relations. It includes the tariff wars of Donald Trump’s presidency, the impact of the pandemic and the Ukraine/Taiwan-related geopolitical and security tensions that have further curbed US investment and trade with China.
There has also been the much-documented “near-shoring” or “friend-shoring” trend that has diverted trade with China to countries such as Mexico or Vietnam.
No matter who wins the race for the White House this November, there is little chance that the next administration will be willing to row back standing China trade curbs. And there is a significant risk that these tensions will be ratcheted higher.
On the other side of the pond, Europe has made noise about reducing its exposure to China, but any action on this front has been limited. So if China’s growth and deflation worries persist or even worsen, then the EU’s still-rising relative exposure to Beijing could leave the ECB with a much different macro policy horizon than its US counterpart. — Reuters
Mike Dolan is a columnist for Reuters. The views expressed here are his own. By MIKE DOLAN
