ROI-To win Europe's embrace, China needs to uncap the yuan: Mike Dolan

By Mike Dolan

LONDON, Feb 26 (Reuters) - With Washington raising barriers, China's push to shift trade toward Europe is running into one big demand: let the yuan rise against the euro and level the playing field.

German Chancellor Friedrich Merz landed in Beijing this week to meet Chinese President Xi Jinping, the most prominent European Union leader to visit since last month's rancorous standoff with U.S. President Donald Trump's administration over Greenland.

Other EU leaders have traveled to China this year, including Finland's Petteri Orpo and Ireland's Simon Harris. French President Emmanuel Macron visited as recently as December.

Europe has once again frozen a trade deal with Trump because of confusion over U.S. tariff policy and wider concerns about bilateral relations. The political optics of a re-embrace of China are not lost on anyone.

But there are brass tacks at stake here.

China is Germany's largest single trade partner, and trade ties between the two regions have grown since the COVID-19 pandemic, even as direct U.S.-China trade continues to plunge. What's more, China's overall trade surplus ballooned to an annual record of $1.2 trillion in 2025.

Yet one critical bone of contention in Europe, which Merz stressed on Wednesday, is that any further expansion of EU-China trade is being distorted by what Europe sees as a deeply undervalued real yuan exchange rate against the euro.

Speaking at a Sino-German business event, the chancellor encouraged Chinese firms to invest in Europe. But he also pointedly argued a moderate appreciation of the yuan would make it easier to open up trade without barriers.

Whether he meant barriers would have to rise if that didn't happen was less clear. Even so, it does seem like he was under pressure to make the point, along with a number of other long-standing grievances about subsidies and dumping.

And in a meeting with Premier Li Qiang, Merz said there were "very specific concerns regarding our cooperation, which we want to improve and make fair."

A 40% REAL FX MOVE

So how worrisome is the euro/yuan exchange rate for Europe, and is China already quietly letting the yuan rise now anyway?

Looking solely at the yuan's rise against the U.S. dollar CNY= this year, there's clearly been heavy local dollar selling, despite reports of hefty state‑bank interventions through December and January to slow the yuan's appreciation.

The renminbi has appreciated against the dollar for nine days in a row and is up about 5.5% over the past year, at its strongest in almost three years. What's not clear is whether exporters are front-loading dollar sales for fear of further losses or simply have more dollars to sell because of rising Chinese surpluses.

But while the yuan has crept higher this month against the euro EURCNY= too, it has, by contrast, barely changed in value against the single currency over the past year and euro/yuan is pretty much where it was as the pandemic unfolded six years ago.

While that looks stable on the surface, it's central to the European gripe.

China's been in semi-deflation since COVID hit, with producer input prices essentially flat. European producers, by contrast, have seen equivalent prices jump by a cumulative 35-40%. The resulting real exchange-rate boost for Chinese competitors has been on that order of magnitude.

Looked at another way, the real effective exchange rate (REER) for China's yuan against a broad trade-weighted basket of currencies has firmed up over the past year - but it's still 16% lower than four years ago.

In a paper last year, Juergen Matthes at the IW German Economic Institute laid out the problem in detail. He argued that the near fourfold increase in Germany's goods trade deficit with China since 2020 was largely driven by that "immense producer price divergence" and a whopping 40% real appreciation of the euro against the yuan.

Matthes goes a step further to say significant currency manipulation is a likely culprit. He cites national accounts and portfolio-flow data that imply about 125 billion euros of yuan demand between 2020 and 2024 that failed to show up in the FX rate.

"These findings provide strong indications for currency manipulation," he concluded. "As European industry is seriously threatened by this development, trade policy action is urgently warranted in order to re-establish a level playing field."

China's reluctance to allow the exchange rate to adjust to that cost gap reflects its persistent reliance on exports to meet ambitious growth targets. Domestic demand remains in the doldrums due to a property bust and dire demographics.

Huge upheavals in geopolitics will no doubt shape what happens next. Europe now has to perform a major balancing act between two economic superpowers at loggerheads.

But, much like Washington has done, Europe now needs to put a stronger yuan firmly on the bargaining table. Otherwise, Beijing has every incentive to keep a lid on it.

(The opinions expressed here are those of the author, a columnist for Reuters.)

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