ECB: Worst Case Scenario Of Chinese Trade Diversion Would Reduce HICP By 0.15pp

An ECB staff blog, published today, suggests a 10% increase in Euro area imports from China under a severe trade scenario could reduce non-energy industrial goods inflation by 0.5pp in 2026, impliyng a negative peak impact on headline HICP inflation of 0.15pp. The estimates are based on the same severe trade scenario outlined in the June macroeconomic projections, where the US effective tariff rate on Chinese goods is 135%. Of course, the current effective tariff rate is closer to ~30% following the May 12 trade agreement, which looks to have been extended for another 90 days after talks between the US and China in Stockholm this week. As such, the estimates should be considered a worst case scenario, not a forecast based on current conditions.

• Staff note that the Euro area could be more impacted by Chinese trade diversion at present compared to 2018 due to:
  • A similar composition of Chinese exports to the US and the EU
  • "Established supply chain links, which have expanded since the last China-US trade war, and ongoing industrial upgrades in China facilitate the redirection of trade flows"
  • "Chinese businesses have laid the groundwork to facilitate faster market entry."
  • "The depreciation of the Chinese renminbi makes Chinese goods cheaper and more attractive for European importers."
  • "Many [Chinese] firms, especially those in final goods production, still have room to absorb reduced profit margins".
• Following a 10% rise in Chinese imports, "assuming that domestic demand remains the same in the short term, this increase in imports would result in an excess supply of goods equivalent to 1.3% of overall goods consumption. For consumers to absorb this additional volume of imported goods – either by replacing other imports or substituting domestic production – the prices of Chinese imports would need to decrease. Specifically, our calculations indicate that lower Chinese import prices would reduce overall import prices by 1.6%."
• "But it will take some time for consumer prices to drop. While stronger supply from China may trigger a swift decline in import prices, consumer prices for non-energy industrial goods (NEIG) tend to respond more gradually, with the strongest impact materialising one to one-and-a-half years after the initial shock".