Central Banks

Why China ‘spillover’ poses risks for the euro zone

China's economic slowdown could pose risks for the euro area ranging from falling exports, capital outflows and exchange rate fluctuations, the European Central Bank (ECB) said on Wednesday.

China is now the second-biggest economy after the U.S. and plays an increasingly major role in global trade. Its economy has slowed each year since 2010 and is seen continuing to do so until at least 2016, when the International Monetary Fund forecasts growth of 6.3 percent.

Port Of Hamburg
Krisztian Bocsi | Getty Images

"The slowing of growth in China since the beginning of 2015 has reduced euro area exports, in particular exports of machinery and transport equipment. This has had adverse repercussions, in particular, for exporters of manufactured goods, which account for almost 90 percent of goods exports to China," the bank said in Wednesday's "financial stability review."

The ECB, which controls monetary policy in the 19 countries that use the euro, said that a 1 percentage point slowdown in Chinese real gross domestic product (GDP) would knock around 0.1-0.15 percentage points off euro area activity after two to three years.

An economic "confidence shock" — perhaps due to a worse-than-expected slowdown in China — could lead to a tightening of financial conditions in emerging markets and a "further slowdown of euro area foreign demand," the ECB said.

"Moreover, capital outflows from China, if not counterbalanced by other private or official flows, could trigger a depreciation of the Chinese currency and, in its wake, exchange rate depreciations of other emerging market currencies," it added.

The bank said that China's huge economy meant it had wielded a "significant effect" on the price of oil, but that this had waned in recent years as its rapid growth slowed.

PetroChina workers at the site of an oil well in Xinjiang, China.
Bloomberg | Getty Images

U.S. crude oil prices have tumbled by around 45 percent over the last year due to an imbalance of demand and supply. This has been partially driven by the economic slowdown of China, which is a major purchaser of commodities.

"The size of the Chinese economy means it has had a significant effect on oil prices, although its relevance has waned in recent years as growth has continued to decline. Therefore, the impact of a slowdown in China on oil prices may be limited, although it crucially depends on whether growth in other emerging market economies slows as well," the ECB said.

The global economic backdrop, including China, could influence the ECB's decision on whether to extend or expand its 1 trillion euro ($1.1 trillion) asset purchasing-program. The central bank is widely anticipated to do so when it meets on December 3 in Frankfurt.

The European Central Bank (ECB) headquarters is pictured in Frankfurt, Germany, September 3, 2015.
ECB announces Christmas break for QE

"The impact on the euro area of a potential further slowdown in China ultimately hinges on the extent to which this slowdown spills over to other emerging markets more generally and the degree to which the resulting loss of confidence affects global financial markets as well as global trade," the bank concluded in Wednesday's report.

— By CNBC's Katy Barnato. Follow her on Twitter @KatyBarnato.