The slow-burning acceleration of China-EU trade frictions, with autos and rare earths becoming key battlegrounds

Overview

This report analyzes why China-EU trade frictions are shifting from a long-term slow-burning risk to a policy conflict with more substantive impact. Nomura points out that the EU's trade deficit with China continues to widen, while China's rising competitiveness in autos, industrial goods, and high value-added manufacturing is creating greater industrial, employment, and political pressure for Europe. The core judgment of the report is that future conflict is unlikely to take the form of a rapid tariff spiral similar to that of the United States, but is more likely to accumulate gradually through multiple channels such as PHEV anti-subsidy measures, price undertakings, tariffs on low-value parcels, foreign subsidy reviews, public procurement restrictions, supply-chain diversification requirements, and rare earth licensing.

Core views

The report's three most important views are as follows. First, the main cause of the China-EU trade imbalance is not transshipment or rerouting caused by US tariffs, but rather a structural "second China shock" jointly driven by China's expansion in high value-added manufacturing capacity, weak domestic demand, and factory-gate price deflation. Second, the EU's policy room is narrowing: the United States no longer sees China as its largest source of trade deficit and is also pressuring the EU, so Europe increasingly needs to deal with China's trade challenge independently. Third, autos, especially PHEVs, are the most likely near-term policy focus, while rare earth permanent magnet licensing is Beijing's most leveraged gray-zone tool.

Analysis framework

The report uses an analytical approach combining macro trade data, sectoral import structures, policy developments, and corporate restructuring cases. The authors compare trade imbalances under the statistical frameworks of China's customs, Eurostat, and the USTR, distinguishing structural supply shocks from trade rerouting; they then break policy tools into the EU side's rules-based, sectoral trade defenses and China's targeted, negotiable retaliation; finally, they use PHEVs, German automakers, steel restructuring, low-value cross-border e-commerce parcels, and rare earth permanent magnet supply chains as transmission case studies.

Methodology notes

• Macro trade and industrial shockSecond China shock

  As China's manufacturing competitiveness expands from low-end products to higher value-added industrial goods, it creates structural pressure on Europe's core manufacturing sectors.

  The report argues that this is not a short-term trade rerouting issue, but a sustained shock jointly caused by capacity, price competitiveness, economies of scale, and industrial upgrading. Therefore, even if China-US trade relations stabilize, the pressure faced by Europe may continue.

• Policy path assessmentSlow-burning trade war

  The conflict gradually accelerates through a multi-sector, multi-tool, legally driven process rather than a one-off comprehensive tariff escalation.

  Constrained by its institutions and differences among member states, the EU is more likely to gradually increase pressure through tools such as anti-subsidy and anti-dumping measures, procurement restrictions, tariffs on low-value parcels, and supply-chain requirements.

• Risk transmissionGray-zone export licensing

  Actual supply is adjusted through licensing approvals, end-use checks, and enforcement intensity rather than through an openly declared comprehensive embargo.

  Rare earth permanent magnets are critical to Europe's EV, wind power, defense, robotics, and electronics industries. Beijing can use the existing export-control framework to lengthen delivery cycles, raise compliance costs, and create allocation uncertainty.

Asset mapping & comparison

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

• European auto and PHEV supply chain

  Most likely to become the core battleground in the EU's next phase of trade defense against China.

  Strengths

  Europe still has a domestic industrial base and high political attention, and the EU can use institutionalized tools such as anti-subsidy measures, anti-dumping actions, and price undertakings.

  Weaknesses

  The PHEV policy gap has already been rapidly exploited by Chinese exports; European automakers have high costs and weak demand, and member-state positions are not fully aligned.

  Comparison

  Compared with BEVs, PHEVs were not previously covered by the EU's 2024 anti-subsidy tariffs, making them a more obvious target for arbitrage and policy patching.

  Risks

  If the EU expands PHEV measures, China may retaliate against large-engine or high-end imported vehicles, with German brands more heavily affected.

• German automakers

  They are both representative of Europe's industrial pressure and sensitive targets for potential Chinese retaliation.

  Strengths

  Volkswagen, BMW, and Mercedes-Benz still hold important market positions and brand assets in China.

  Weaknesses

  The report notes that all three German automakers saw declining sales in China, while also facing pressure from Chinese competition, US tariffs, and weak demand in their European home market.

  Comparison

  Germany has traditionally tended to favor stable China relations, but the weakening competitive position of its companies in China makes its stance more complex.

  Risks

  If trade frictions intensify, large-engine cars, luxury vehicles, or access to the Chinese market could become channels for Beijing's retaliation.

• Rare earth permanent magnet supply chain

  Beijing's most leveraged gray-zone tool.

  Strengths

  China has critical influence in medium and heavy rare earths, permanent magnet materials, and export licensing.

  Weaknesses

  Europe has limited short-term substitution capacity, and new capacity requires capital, technology, permits, environmental approvals, customer certification, and long-term procurement commitments.

  Comparison

  Compared with an openly declared embargo, licensing delays and end-use reviews are more flexible and harder to trigger a unified response against.

  Risks

  EV, wind power, defense, robotics, and electronics sectors may face longer delivery times, rising compliance costs, and uncertainty in supply allocation.

• Temu, Shein, and Chinese cross-border e-commerce low-value parcel chains

  EU tariffs on low-value parcels and potential handling fees will directly raise the cost of entering the European market.

  Strengths

  Chinese platforms are competitive in low-priced consumer goods and fulfillment scale.

  Weaknesses

  Low-value parcels are a key focus of EU policy, and the temporary EUR 3 per-item tariff starting in July 2026 will affect parcels valued below EUR 150.

  Comparison

  Unlike traditional industrial anti-subsidy measures, this channel is more related to customs systems and e-commerce regulation.

  Risks

  If follow-on handling fees are implemented, platform subsidies, logistics costs, and end prices may come under pressure.

• EU agricultural and consumer goods exports

  May become politically sensitive targets of China's calibrated retaliation.

  Strengths

  Some products have brand and origin advantages, and both sides still retain room for price undertakings and negotiations.

  Weaknesses

  Sectors such as brandy, pork, and dairy products can easily create political pressure on specific member states.

  Comparison

  In previous cases involving pork, dairy products, and brandy, China's final measures were often less severe than the initial high-pressure stance, showing that retaliation is more of a negotiating lever.

  Risks

  If the EU advances PHEV or procurement restrictions, China may expand targeted trade remedies or market-access restrictions.

Key data

• China's goods trade surplus with the EUUSD 291.8 billion in 2025, versus USD 132.4 billion in 2020Based on China's customs data, the report notes that the surplus has widened significantly and continued to rise in 2026.
• China's surplus with the EU in the first five months of 2026USD 143.8 billion, up 23.0% year on yearDuring the same period, exports to the EU grew 16.4%, while imports from the EU grew 8.6%.
• EU goods deficit with China under Eurostat statisticsEUR 365.0 billion in 2025; EUR 98.0 billion in Q1 2026The deficit in Q1 2026 was the highest since Q3 2022.
• EU imports of PHEVs from ChinaAbout 42,600 units in 2024, about 171,300 units in 2025, up about 302%About 97,400 units in January-April 2026, up about 130% year on year.
• China's share in the EU's extra-EU PHEV imports21.3% in 2024, 45.4% in 2025, 63.0% in January-April 2026The report believes China contributed the bulk of marginal import growth.
• Comparison of the US goods deficits with China and the EUIn 2025, the US deficit with China was USD 202.1 billion, versus USD 218.8 billion with the EUThis weakens the US incentive to once again lead a broad trade escalation against China.
• China's exports of rare earth permanent magnets to the EU's four largest economiesVolume up 52.3% year on year in January-May 2026Germany accounted for about 68% of the combined total of Germany, France, Italy, and Spain.

Impact & implications

For investors, the report highlights not the risk of a single tariff announcement, but the persistent impact of product-level reviews, procurement access restrictions, supply-chain requirements, and licensing uncertainty on corporate margins, delivery cycles, capital expenditure, and valuation discount rates. European sectors such as autos, steel, chemicals, medical devices, wind power, defense, and robotics face greater policy uncertainty; meanwhile, Chinese automakers, cross-border e-commerce platforms, and industrial export chains may face denser EU market-access costs and compliance pressure. German automakers are in a dilemma: on the one hand, they rely on the Chinese market and worry about retaliation; on the other hand, they are being squeezed by Chinese competitors in both Europe and China.

Risks

• If the EU's October assessment concludes that the China-EU consultation mechanism lacks substantive results, PHEV, trade defense, and e-commerce handling-fee policies may accelerate in Q4.
• China may raise the EU's political costs through channels such as large-engine vehicles, brandy, pork, dairy products, chemicals, or public procurement.
• If rare earth permanent magnet licensing tightens, European EV, wind power, defense, and industrial automation supply chains may face delivery-time and compliance-cost shocks.
• Differences among EU member states may make the policy path unstable, potentially both slowing decision-making and then abruptly toughening it after political pressure rises.
• The market may underestimate slow-burning frictions because the risk will not be concentrated in a single large-scale tariff announcement.

What to watch

• Progress in China-EU working-level consultations, trade-flow monitoring, and industry negotiations from July to September 2026.
• The EU's October 2026 judgment on outcomes in trade rebalancing, market access, and rare earth licensing.
• Whether the EU formally advances anti-subsidy or other trade defense measures on China-origin PHEVs.
• Implementation of the EU's temporary EUR 3 per-item tariff on low-value parcels and whether additional handling fees are introduced.
• China's retaliation signals toward EU large-engine vehicles, agricultural products, alcoholic beverages, chemicals, or public procurement.
• Approval speed for rare earth permanent magnet export licenses, along with changes in delivery times and inventories at European manufacturers.
• Shifts in the positions of member states such as Germany, France, Spain, and Austria on trade policy toward China.
• Changes in restructuring, sales, and China market exposure for companies such as Volkswagen, BMW, Mercedes-Benz, Renault, and Thyssenkrupp.