Column: ECB’s Urgency May Be Driven by Intensifying EU-China Trade Relations – Mike Dolan, Reuters

By Mike Dolan

LONDON – Although discussions continue regarding the West’s strategic decoupling from China’s faltering economy, Europe’s direct trade relations with Beijing appear to be on the rise.

This contrast may clarify the differing approaches to monetary easing between the Federal Reserve and the European Central Bank (ECB). The ECB is anticipated to implement its second interest rate cut before the Fed even begins its adjustments next month, with a potential third cut expected in October.

If China’s economy continues to falter, the disparity between the Fed and the ECB could become more pronounced.

Concerns are escalating regarding the state of China’s economy, the world’s second-largest. Despite numerous attempts by Beijing to stimulate domestic consumption, the country faces ongoing sluggishness, a persistent property market downturn, looming consumer and producer price deflation, and increasing trade tensions. Central bankers at the recent Federal Reserve symposium in Jackson Hole expressed apprehension about the potential negative impact of China’s slowdown on the global economy.

This week, investment bank UBS lowered its growth forecast for China in 2025 to just 4%, falling short of Beijing’s 5% target and below the International Monetary Fund’s estimate of 5.1%. While China’s economic challenges will undoubtedly impact both the U.S. and Europe, the latter seems to be facing more significant difficulties.

The Peterson Institute for International Economics highlighted the extent of this divergence based on its analysis of customs-cleared data from last year. The report indicated that while the United States has sharply reduced its reliance on Chinese imports over the last five years, the European Union’s share of imports from China has actually increased.

The growing trade relationship between China and the EU is particularly evident in manufactured goods. China depends less on the U.S. for its manufactured imports, while its purchases of EU goods have risen significantly compared to five years ago. This strong connection is further illustrated by the yuan making up more than 18% of the euro’s trade-weighted index, exceeding the yuan’s share in the equivalent index for the dollar by about 5 percentage points.

PIIE authors Mary Lovely and Jing Yan presented a ‘geo-economic’ perspective on these trends, noting, "Despite the Biden administration’s efforts to encourage the European Union to reduce its dependency on Chinese imports, the opposite trend has emerged. Europe has become more reliant on China while the United States has become less so. This growing divergence in economic interests may complicate future agreements on national security and technology policies involving Chinese imports."

For most investors, the key takeaway is straightforward: Europe’s significant economic reliance on China poses serious implications for growth, inflation, and consequently, central bank policy.

This analysis covers a critical period in U.S.-China relations, encompassing the tariff conflicts of Donald Trump’s presidency, the pandemic’s effects, and the geopolitical tensions surrounding Ukraine and Taiwan, all of which have dampened U.S. investment and trade with China. Furthermore, the notable trends of ‘near-shoring’ or ‘friend-shoring’ have redirected trade away from China toward countries like Mexico or Vietnam. Regardless of who occupies the White House next November, it seems unlikely that the new administration will reverse existing trade restrictions on China, with the potential for escalating tensions.

In contrast, Europe has expressed intentions to lessen its exposure to China, but any substantive action has been limited.

If concerns about China’s growth and deflation worsen, the EU’s increasing dependence on Beijing could lead to a markedly different macroeconomic policy landscape for the ECB compared to that of the U.S. Financial markets have traditionally viewed the ECB and Fed’s monetary policy cycles as closely linked; however, this current cycle demonstrates otherwise. The ECB has commenced rate cuts well ahead of the Fed, with U.S. policy rates currently over 150 basis points higher than those of the ECB.

The challenges stemming from China’s economy may explain why the ECB has been willing and able to take preemptive measures compared to the Fed this year. Nevertheless, markets do not seem to reflect this understanding, with expectations of 50 basis points more easing from the Fed in the coming year compared to the ECB.

Recently, the euro reached a one-year high against the dollar, raising questions about how relative pricing may shift if conditions in Beijing further deteriorate. There is little doubt that China’s economy remains a major force globally, accounting for around 35% of the world’s manufacturing output.

However, investors may need to consider how severely those challenges could impact Europe.

The views expressed here are those of the author, a columnist.