EASING INFLATION: A farmers' association in Paris sells 60 tons of fruits and vegetables below retail prices to help combat inflation

This year, the weakening U.S. economy is the biggest trigger for shrinking Chinese exports. But next year, we believe that the European economic slowdown will become the biggest threat to Chinese exports.

Economists at Deutsche Bank's European branches recently slashed the euro zone's GDP growth for 2009. They expect a 1.2-percent and a 0.1-percent GDP growth in 2008 and 2009, respectively, much lower than their previous forecasts of 1.7 percent and 0.8 percent. They also argue that the exchange rate of the euro against the U.S. dollar will fall to 1.35 or less by the end of 2009.

Therefore, considering the circumstances of a 0.1-percent GDP growth in Europe and the euro's depreciation of about 10 percent versus the renminbi next year, we estimate that China's exports to Europe will fall to zero growth from the current 26-percent growth rate.

The new challenge for China's exports and the investment growth slowdown caused by falling housing prices demand that the Chinese Government readjust its macrocontrol policies, and in particular loosen its monetary and fiscal policies.

We cite several reasons for Deutsche Bank slashing the economic outlook: the shrinking external demand for European products, investment decreases caused by credit constringency, the negative impact on consumption due to high commodity prices, and more bank deposits due to falling property prices.

In the short term, the euro zone might fall into recession in the second and third quarter of this year, and its economic growth might fall on a month-on-month basis. We therefore estimate that the euro will continue to depreciate against the U.S. dollar during the second half of this year. If we assume the U.S. dollar will maintain its exchange rate to the renminbi, then we expect that the euro might depreciate 15 percent against the renminbi from this July to the end of next year.

We attribute the euro's weakening to the following three reasons:

First, the risks of economic recession in the euro zone are accumulating, while inflationary pressure is being relieved. Hence, the European Central Bank (ECB) is likely to start cutting rates as of the first quarter of next year. We estimate that the ECB might cut 100 basic points during 2009. Across the Atlantic Ocean, the U.S. Federal Reserve (Fed) will likely maintain the benchmark rates, but interest rate hikes are possible. As a result, the interest rate difference between the euro zone and the United States will prop up the U.S. dollar.