China-EU trade friction has entered a more substantive slow-burn escalation phase

Overview

The report revisits Nomura's December 2025 view that China-EU trade friction would become a significantly underpriced market risk in 2026. Recent data and policy shifts suggest this view has broadly materialized. China's goods surplus with the EU continues to make new highs, EU policy posture toward China has clearly hardened, while the United States is no longer the sole or dominant driver of China trade pressure as in the past. The report expects the dispute to enter a more substantive phase, but the pattern is not a fast-moving U.S.-style tariff spiral; instead it is a slow-burn escalation driven cumulatively by multiple sectors and policy tools.

Core views

The report has four core points. First, the source of pressure on China's exports to Europe is a "second China shock," with Chinese manufacturing competitiveness extending into higher-value sectors such as automotive, machinery, chemicals, and electronics; trade diversion is only an amplifying factor. Second, the EU is under greater domestic political pressure, especially because trade shock is becoming visible through automobiles, steel, and supply-chain restructuring, and Germany can no longer maintain its traditional stance of relying primarily on stable ties with China. Third, PHEV is likely to become the EU's next most important automotive trade defense target because the 2024 BEV anti-subsidy tariff did not cover PHEV, leading to rapid growth in China-origin PHEV exports to the EU. Fourth, China’s retaliation is expected to remain calibrated, targeted, and still preserve negotiation space, with rare-earth and permanent-magnet licensing as the most deterrent gray-zone instruments.

Analysis framework

The report centers on trade data, policy timelines, and sector exposure, comparing Chinese customs, Eurostat, and USTR data, and incorporates recent EU policy tools such as anti-dumping, anti-subsidy, low-value parcel tariffs, foreign subsidy reviews, and public procurement restrictions to map the likely escalation path of China-EU friction in the second half of 2026. It also traces transmission channels by examining PHEV imports, German automakers’ sales in China, European corporate restructuring, and rare-earth permanent-magnet dependence.

Methodology notes

• Macro trade analysisSeparating structural shock from trade diversion

  Second China Shock

  The report attributes the expansion of China-to-EU exports primarily to high-value manufacturing capacity growth, weak domestic demand, and price competitiveness, rather than simple trade diversion from U.S. tariffs, implying pressure may be persistent.

• Policy pathway analysisSlow-burning trade friction framework

  Sector-level cumulative pressure

  The report suggests the EU is more likely to gradually increase pressure through PHEV anti-subsidy actions, low-value parcel tariffs, public procurement restrictions, foreign subsidy reviews, and supply-chain requirements rather than a one-time broad tariff escalation.

• Supply chain risk analysisGray-zone licensing tools

  Rare-earth and permanent magnet export licensing

  The report emphasizes that risk may not necessarily come from an explicit ban, but could arise from slower approvals, tighter end-use scrutiny, higher compliance costs, and allocation uncertainty.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• European automotive and PHEV value chain

  Potential core battleground of EU trade defense

  Strengths

  Europe has a domestic automotive industrial base and policy mobilization capability.

  Weaknesses

  After a PHEV policy gap is exposed, China-origin imports grew rapidly, putting European automakers under pressure in both domestic and China markets.

  Comparison

  PHEV reflects policy arbitrage more directly because the EU's 2024 BEV anti-subsidy tariff did not cover PHEV.

  Risks

  EU expansion of anti-subsidy measures, Chinese retaliation against large-engine or high-end imported vehicles, and pressure on German automakers' China operations.

• Rare earth and permanent magnet materials

  China's most leveraged gray-zone anti-countermeasure against the EU

  Strengths

  China has strong control over medium-heavy rare-earth and high-performance permanent magnet supply chains.

  Weaknesses

  European short-term substitution capacity is limited, and new capacity build-out requires capital, technology, licensing, environmental approval, and customer qualification.

  Comparison

  Compared with open tariffs or bans, slower licensing is more flexible and harder to be reciprocally countered in a coordinated way.

  Risks

  Approval delays, longer lead times, higher compliance costs, and greater production uncertainty for EV, wind, robotics, and defense manufacturers.

• Low-value cross-border e-commerce and consumer goods imports

  Directly affected area of EU low-value parcel rule changes

  Strengths

  Chinese platforms and supply chains still have cost and scale advantages.

  Weaknesses

  The low-value parcel channel faces a temporary EUR 3 tariff and potentially handling fees.

  Comparison

  Compared with traditional anti-dumping, low-value parcel rules have a broader coverage and affect many small-value consumer goods.

  Risks

  Higher fulfillment costs, reduced platform pricing advantage, and tougher compliance and customs data requirements.

• European steel, chemicals, and industrial goods

  Political transmission channel for trade shock and corporate restructuring pressure

  Strengths

  The EU can deploy anti-dumping, anti-subsidy, public procurement, and industrial resilience tools.

  Weaknesses

  High energy costs, weak demand, U.S. tariff pressure, and Chinese competition jointly squeeze profitability.

  Comparison

  These industries do not have a single focal product like automobiles, but more clearly reflect broad manufacturing pressure.

  Risks

  Employment and capacity restructuring intensify, pushing EU politics toward more defensive policy choices.

Key data

• China-EU goods surplusUSD 291.8bn in 2025; USD 143.8bn in Jan-May 2026, up 23.0% year-on-yearThe report cites Chinese customs data and says the surplus continues to expand and set record highs.
• EU merchandise deficit vis-à-vis ChinaEUR 365.0bn in 2025; EUR 98bn in Q1 2026The report says the Q1 2026 deficit is the highest since Q3 2022.
• China-origin PHEV imports into the EUabout 42,600 units in 2024; about 171,300 units in 2025; about 97,400 units in Jan-Apr 2026Around 302% growth in 2025, and around 130% year-on-year growth in Jan-Apr 2026.
• Share of EU non-EU PHEV imports from China21.3% in 2024; 45.4% in 2025; 63.0% in Jan-Apr 2026The report argues China is driving the marginal growth in the EU's external PHEV imports.
• Sales pressure on German automakers in ChinaVolkswagen delivered 2.69mn vehicles in China in 2025, down 8.0% year-on-year; BMW 625,500 vehicles, down 12.5%; Mercedes-Benz 551,900 vehicles, down 19%The report says this makes Germany's position more complex, as it both fears retaliation and cannot ignore Chinese auto competition.
• China-to-EU rare-earth permanent magnet exportsChina's exports of rare-earth permanent magnets to Germany, France, Italy, and Spain grew 52.3% year-on-year in Jan-May 2026Germany accounted for 68% of the four-country total, indicating limited short-term European substitution capacity.
• Policy timingJuly 2026: temporary EUR 3 low-value parcel tariff takes effect; October 2026 is a key checkpoint for EU assessment of China-EU dialogue outcomesIf no substantive progress is seen in negotiations, the EU may push stronger tools in Q4.

Impact & implications

For assets and sectors, European automobiles, auto parts, steel, chemicals, medical devices, low-value cross-border e-commerce platforms, rare-earth permanent magnets, and wind/EV/defense supply chains could all be affected. Risks for European firms are not only tariff costs but also market access, public procurement, supply-chain compliance, import licensing, lead times, and capex uncertainty. Chinese exporters may still be able to maintain share through price competitiveness, RMB exchange rate, and capacity advantage, but policy friction is likely to raise the structural cost of entering the European market.

Risks

• The EU judges after October that no substantive progress has been achieved in talks and pursues stronger PHEV, trade defense, or supply-chain tools.
• China undertakes targeted retaliation through large-engine vehicles, agricultural products, wine, chemicals, or market-access restrictions.
• Rare-earth and permanent-magnet licensing slows down, raising uncertainty in lead times and costs for European EV, wind, robotics, and defense supply chains.
• Cautious member states such as Germany, if under employment and industrial restructuring pressure, may be forced to back tougher EU policies.
• If policy tools are layered, firms may underestimate the cumulative impact of slow-burning friction on margins, capex, and supply-chain decisions.

What to watch

• Progress in China-EU technical-level talks from July to September 2026.
• EU evaluation in October 2026 of trade rebalancing, market-access, and rare-earth licensing outcomes.
• Whether the EU initiates or expands anti-subsidy or other trade defense measures on China-origin PHEV.
• Whether China takes further measures against European large-engine cars, branded wine, pork, dairy products, chemicals, or medical devices.
• The pace of rare-earth permanent magnet export licensing approvals, lead times, end-use screening, and import rebound conditions in Germany, France, Italy, and Spain.
• Whether RMB/euro movements, Chinese export prices, and PPI changes weaken China's export price competitiveness.