EU markets recover after China's Black Monday

Events in Shanghai had caused pandemonium on Monday, wiping $2.7 trillion (€2.3 trillion) off global share prices. European shares had their largest single-day fall since 2008 - the height of the financial crisis.

On Tuesday morning (25 August), the People’s Bank of China (PBoC) reacted by introducing its fifth interest rate cut since last November. The bank reduced its one-year lending rate to 4.6 percent in a clear signal it’s prepared to head off a repeat of the stock market crash which hit the country in June.

Despite the PBoC intervention, the benchmark Shanghai Composite fell by a further 7.6 percent on Tuesday, taking its losses over the past four trading days to more than 20 percent.

The euro has also gained 3 percent against the dollar and sterling, although at $1.14 it is still slightly weaker than it was when the European Central Bank (ECB) announced its €1.1 trillion bond-buying programme in January.

If this is confusing, it’s because there aren’t many signs that the European economy is actually that vulnerable to turmoil in the Far East. For example, the index on German business confidence has increased in August, indicating belief that its export-driven economy won’t be harmed.

Europe is less dependent on Chinese imports and exports relatively little in return.

Many of the container ships which ply the sea routes from Asia return there carrying empty boxes, or boxes full of recycled paper to make packaging for Chinese products.

This means that a drop in spending by Chinese consumers, who saw their savings and pensions suffer a huge blow over the past week, shouldn’t hurt European firms too much.

“What happened yesterday was purely panic,” said Commerzbank economist Peter Dixon.

“We’re overplaying the impact the Chinese collapse would have on Europe. The risks are still high, and sentiment is still fragile”.

"Markets are beginning to realise this is a Chinese problem, not a European one,” he added. “These are specific issues which refer to fundamentals in other markets and do not reflect the situation in Europe”.

For the time being, European economies are less likely to be hit by a slowdown in Chinese growth than the likes of Japan, Australia, and the US, whose firms have greater exposure to and higher investment in China.

But in the long term, if the Chinese economy stagnates, European consumers will pay a price, particularly in countries whose economies are more reliant on borrowing and domestic consumer spending.

China has been willing to buy large amounts of European and US debt while its economy was booming, but may be more reluctant to prop up Western borrowing if confidence evaporates at home.

The China crisis has also underscored the continuing volatility in financial markets and the fact that the world’s largest trading blocs - China, the US, and Europe are significantly out of kilter with each other, both in terms of economic and monetary policy.

The PBoC has cut interest rates five times since November.

But the European Central Bank has been buying €60 billion of government and private bonds since March as part of a quantitative easing programme set to last until September 2016.

By contrast, before the summer holidays most market analysts expected the US Federal Reserve to increase interest rates twice by Christmas.

The Bank of England is also in line to raise rates, although in both cases, the uncertainty in China is now likely to delay rate increases.