The cost of the Chinese "zero-Covid"

More than two months have passed since Russia attacked Ukraine. The expected impacts on Europe are known, and growth prospects have already suffered. They are even already expected by the markets, which fell by 8% (for the Stoxx50) following the invasion on 24 February. The cost of China's zero-covid policy and the containment of Shanghai, on the other hand, is not yet expected. Is this the straw that will break the camel's back and guarantee a European recession?

The containment of Shanghai and its 25 million inhabitants for more than five weeks has closed a large number of factories and the world's largest port. While these closures were only supposed to last two weeks, the prospects for reopening continue to be delayed, and with them, the risks of adverse consequences for Europe are increasing. Already, Chinese growth figures for April have shown a sharp decline. Beijing has announced support measures, but as long as this zero-covid policy persists, lock-ins will not stop and growth will suffer. While the government expects annual growth of 5.5%, experts' expectations are more like 4.5%, which could fall further if the anti-Covid measures remain rigid.

This is an additional obstacle for Europe. China overtook the US in 2020 to become the EU's largest trading partner. It is the third-largest destination for EU exports, with Germany as the largest exporter, and the largest partner for imports. Europe is therefore highly dependent on Chinese growth. Moreover, many assembly parts come from China, and delivery delays and shortages of basic components are likely to increase again, as they did during the first confinements of 2020 - just as the situation was improving. Add to this the risk of power cuts due to the war in Ukraine, and the lack of raw materials or parts needed for industrial production, especially in Germany, may create pockets of recession in the European economy.


The Chinese decisions will have a global impact, including on the US, but Europe is again most at risk. The impact could also increase the divergent views within the European Central Bank, where a large number of members have become hawkish and are confronting Madame Lagarde who remains convinced, rightly, that rate hikes will not improve the current situation. Energy prices will not fall as long as the conflict in Ukraine continues, even if the ECB raises rates. Similarly, supply chain bottlenecks cannot be solved by higher rates. Unlike the US, too much demand is not a problem in Europe. However, with German annual inflation at 7.5% in March, it will be difficult for the ECB not to act, although we do not think it will tighten policy as much as the market now expects.

While Americans are less exposed to Chinese growth, supply chain disruptions are likely to push prices back up, when there was a bit of a lull. Here, central bankers are unlikely to be very concerned about growth, but rather about inflation - their number one enemy - which would add to their dilemma. Therefore, the Federal Reserve is unlikely to deviate from its path of monetary tightening, and the markets could suffer if inflation figures rise again.

What about Switzerland?

Switzerland is less directly exposed to China, and its global exports allow it to better navigate a European slowdown, but we will certainly not be completely spared. The impact of the war is already being felt in Switzerland, if only in terms of energy prices. Switzerland does not have the same inflation concerns as other countries - and has instead been fighting deflation for many years - but the question of rate hikes is still on the table given the surge in prices (2.5% in April compared to 2021). However, with the strengthening of the franc, the Swiss National Bank is unlikely to raise rates any time soon, fearing strengthening the currency further, especially compared to our biggest trading partner, the EU.

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