(This story was originally published Friday)
By Christopher Emsden
OF DOW JONES NEWSWIRES
MILAN (Dow Jones)--China's surprise interest rate hike Friday added a new warning to Europeans that their big export markets, for years the primary drivers of Europe's economic growth, are being forced to slow down.
The big U.S. market, the main trading partner for the European Union's 25 members, is losing steam as a series of U.S. interest rate increases drag on the nation's retail and housing markets.
In China, costlier credit and a strengthening yuan could soon begin to take some heat out of theEU's second largest source of trade. But economists said more steps than Friday's 27 basis-point rate increase would be needed to cool China's booming economy.
Signs of slowing export demand aren't expected until later this year or in 2007. But trends overseas raise questions here about whether the EU domestic economy can make up the slack, and how aggressively the European Central Bank should raise its own interest rates.
"What China has done so far shouldn't affect Europe much yet," said Thomas Harr, an analyst at Danske Bank in Copenhagen. "But I'm quite sure they will do more."
The effect could be twofold. "A rising currency and higher credit costs together should begin to slow down China's import-export cycle," Harr said.
China is a fast-growing market for Europe's exporters but for now its size remains modest, accounting for only 5% of EU exports, according to the EU's Eurostat statistics agency. The U.S., by contrast, accounts for nearly a quarter of the EU's exports outside its region.
"A slowdown in Chinese economic growth from 11% in the second quarter to 8% would have only modest consequences for the euro zone, worth hardly 0.1% of gross domestic product," said Holger Schmieding, Bank of America economist in London.
The euro zone's incipient recovery - to an expected rate of around 2.1% this year from 1.3% in 2005 - has been spurred largely by exports. Only in recent months has data indicated it is broadening out and likely to enjoy sustainable domestic consumption.
"Domestic demand in the euro zone can partly compensate some slowdown in the world economy including China," said Jose Luiz Alzola, an economist for Citigroup in London. "But other potentially factors still have to bite."
The factors likely to weigh on domestic demand include plans by some major euro area governments, such as Germany and Italy, to tighten their fiscal policies next year. And demand for credit has yet to slow in the wake of the ECB's interest rate hikes since since December.
Market participants widely expect the ECB to raise rates again in October. But the case for another hike in December is less clear because of a possible slowdown, Alzola said.
"The decision at that stage will very much depend on the ECB's projection for inflation in 2008," he said. Here China also plays a major role that might obscure trends. In recent years, Chinese exports have had a softening effect on global goods prices, not least in Europe, allowing central banks to run lower interest rates.
But "the disinflationary trend from China seems to be losing some steam," said Luigi Speranza, an economist at BNP Paribas. He noted that unit prices of Chinese textile exports to Europe declined steadily last year but abruptly rose by 9% in the first quarter of 2006.
More inflationary pressure is in the pipeline after the Chinese government ordered higher minimum wages. These included hikes of as much as 42% in Guangdong province, home to a third of China's exports.
-By Christopher Emsden, Dow Jones Newswires; +39-02-58-21-99-05; email@example.com (Christian Vits in Frankfurt and Terence Roth In Stockholm contributed to this report.)
(END) Dow Jones Newswires
August 21, 2006 02:45 ET (06:45 GMT)
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