From the Middle Kingdom to the United Kingdom: spillovers from China

By Robert Gilhooly, Jen Han, Simon Lloyd, Niamh Reynolds and David Young of the Bank’s International Directorate.

• China’s credit boom is one of the largest and longest running ever recorded. Similar credit booms have typically preceded crises in other countries.
• This article provides an updated assessment of how a shock to the Chinese economy could affect the UK economy via standard transmission channels - such as trade and financial linkages. It then considers how amplification mechanisms, which could plausibly operate in the event of a particularly large shock, could further increase the impact on the UK from an economic crisis within China.
• We find that the effects via standard channels 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.

Overview

The effects from a Chinese hard landing on the UK economy will depend on how the shock transmits through the global economy and financial markets.

Direct links between the UK and China via trade are 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. While China remains relatively unintegrated with the global financial system, the UK is unusual in having a stronger link via Hong Kong. In contrast, sharp falls in commodity prices following a hard landing in China could act to offset some of the negative effects on the UK; petrol prices should fall supporting household spending, for example.

On top of the standard channels, a hard landing in China may trigger amplification mechanisms which could compound the impact on the UK economy. 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 in demand for UK exports and wealth and investor confidence. And a China shock could potentially interact with existing UK vulnerabilities: commercial real estate has been supported by foreign investors, in particular from Asia.

From the Middle Kingdom to the United Kingdom: spillovers from China