The Bank of England has warned that the health of China’s economy poses a greater risk to the UK’s financial stability than previously realised.
New analysis from the Bank has found that a sharp economic slowdown in China would have a serious impact on the UK. If China’s credit boom blows up, Britain would suffer serious economic harm, it says, adding: “China’s credit boom is now one of the largest and longest running ever recorded. Indeed, rapid credit expansions, such as China’s, have typically preceded financial crises.”
The warning came as the trade dispute between the US and China escalated this week, with Donald Trump threatening to impose tariffs on an extra $200bn (£152bn) worth of Chinese goods exported to the US on top of $50bn previously announced. China immediately said it would retaliate, increasing fears of a trade war which could send the global economy into a new slump.
The Bank’s economists have forecast that even a modest economic shock would knock 3% off China’s GDP and reduce UK GDP by up to 0.5%. They said that direct links between the UK and China via trade were very small – only 4% of UK exports go to China.
But China is a key player in global supply chains, meaning that indirect trade effects, for example via the euro area, are much more significant.
A full-blown financial crisis that wiped 10% off China’s economy would knock 1.4% off the UK’s GDP, they believe. But the full impact could be twice as bad, due to “amplification effects” that would drive down asset prices and rock the currency markets.
The Bank warned: “We find that the effects via standard channels [trade, financial links and commodities] from a modest fall in Chinese GDP are larger than our previous estimates, primarily due to China’s increasing role in global trade.
“A more extreme shock which triggers amplification mechanisms – such as a larger financial market reaction – could potentially double the effects from the standard channels alone.
“The financial market reaction to a China crash is as yet untested; hence, a more extreme shock to exchange rates and asset prices could occur, resulting in greater declines demand for UK exports and wealth and investor confidence.”
The Bank has calculated that the City is more exposed to China than previously thought, owing to its links with Hong Kong. It said: “Unlike most countries, the UK is unique in having both sizeable direct exposures to mainland China, and indirectly via UK banks’ exposures to Hong Kong.
“Together, UK banks’ exposures to mainland China and Hong Kong exceed exposures to the US, euro area, Japan and Korea combined, despite the UK economy being a 15th of the size of these economies combined.”
There is another risk which the Bank has not included in its calculation, which is Chinese investment in UK property and which it says is difficult to estimate.
But it added: “It appears that investment from Asia has risen notably since 2010 and accounted for over 40% of London commercial real estate purchases in 2017, up from only 6% in 2010. And as flagged in the [Bank’s] financial stability report, London commercial real estate valuations look stretched.”
