INSIGHT: Central bank credibility could erode in face of fresh inflation challenges
Tom Brown
28-Jan-2025
LONDON (ICIS)–The credibility that central banks have built up over the last few years has helped to contain the surge in inflation, but their capacity to calm markets could erode in the event of unexpected fresh challenges.
Despite their importance, central banks traditionally have very few options to influence the economy, essentially boiling down to a lever that monetary policy committees can push up or down to move interest rates.
The development of unconventional monetary policy, such as the European Central Bank’s campaign of buying up risky sovereign debt and company securities, expanded that toolkit to an extent.
That asset-backed securities purchase scheme has been discontinued since July 2023 and in general the options available to central banks are far more limited than their prominence in global markets over the last few years would indicate.
SURGE AND CONTAINMENT
Through the post-pandemic inflation surge,
central banks have had the task of bringing
down levels, first through hiking interest
rates, then attempting to bring those rates
down without sparking a fresh surge in
inflation.
This task, of shifting from almost non-existent inflation for most of the post-financial crisis period to levels of over 10% in just over a year, was further complicated by the strange dynamics of that surge.
Despite the ECB’s main refinancing rate rising from zero to 4.5%, and the US Federal Reserve’s key rate rising to over 5% in a highly compressed time period, wage and job growth continued to grow, in turn making inflation more stubborn.
The disinflationary period that followed has also proven volatile, as rates tick up and down and raw material costs stay high despite weak industrial growth
Despite this volatility, central banks have been successful so far at slowly bringing down rates.
This progress may be slower than market players had hoped, with 2024 turning into 2025 potentially turning into 2026 without any substantial uptick in global economic growth or industrial demand. But the overall trajectory of bringing down inflation and cutting rates has been steady so far.
The success so far has helped to maintain central bank credibility, as the sense that monetary policy committees have some degree of control over the situation helps to prevent market panics and any wider sell-offs.
“One of the great achievements in that inflation episode we’re just coming out of is the fact that inflation expectations remained very well anchored in most countries in the world,” said IMF chief economist Pierre-Olivier Gourinchas at a press conference this month.
“Central banks were able to rely on the credibility that they had accumulated over the years and convince households and businesses that they would not let inflation run away,” he added.
PRESSURES GROWING
AGAIN
Despite central bank
success at bringing down interest rates without
substantially reigniting inflation, rates have
been slowly creeping up in some markets.
Eurozone inflation firmed for the third consecutive month in December to 2.4%, driven in part by higher energy costs that have only increased into 2025.
Input cost increases are also intensifying, with inflation intensifying at the highest rate in 21 months for the eurozone, despite only moderate service sector growth and continued recessionary conditions for manufacturing.
The UK, similarly, is currently in danger of entering a phase of “stagflation”, where inflation remains high despite stagnating or falling growth. China is a different picture, with inflation low and input prices continuing weak.
The US, which continues to outperform Europe economically and saw manufacturing sector output return to growth in January, has also experienced another month of firmer input costs and the highest rate of goods price inflation in 10 months.
TARIFFS
There is also the
question of the impact tariffs will have on
global inflation trends. Governments are
increasingly adopting protectionist measures
such as anti-dumping duties to safeguard
domestic industries.
The new US administration has also promised fresh tariffs. These have failed to materialise at the rate initially expected, with levies on Canada and Mexico absent from inauguration day announcements, and little mention of Europe.
US President Donald Trump has signalled willingness to deploy tariffs quickly as situations evolve, imposing then revoking emergency measures on Colombia late last weekend, and calling on Monday for 25-100% on Taiwan-made semiconductors.
Trump has also called for the Federal Reserve to move faster in bringing down rates, although there is no indication at present that the bank’s monetary policy committee intends to comply.
CREDIBILITY SHOCKS
Central bank credibility through the gauntlet
of market shocks seen in the last five years
has been maintained through providing the
impression of having a grasp of market
movements and how to control them.
There is a danger, Gourinchas noted, that the effort expended to keep a grip on the market so far, in the face of continuing volatility of inflation and a weak economic recovery, may have eroded central banks’ “credibility capital”.
“If we were to have a new sequence of increase in price pressures… under some of the risks that would be associated with… expansionary policies in some parts of the world or some supply-constraining policies, then that capital may be eroded,” he added.
If hotter pricing conditions and chilly growth rates continue to flow through the west, then there is a danger that inflation expectations could become de-anchored, Gourinchas said. This could result in businesses and households becoming more cautious in general, and quicker to take fright at negative market signals.
“Households, people, businesses may be very, very cautious and very reactive in adjusting their prices and their inflation expectations going forward. That would make the task of central banks much more difficult,” Gourinchas said.
“In this environment, monetary policy may need to be more agile and proactive to prevent expectations from de-anchoring, while macro-financial policies will need to remain vigilant to avoid a build-up of financial risks,” he added.
So far, central banks have more or less managed to plot a steady course through a narrow strait as they gradually unwind interest rate highs and inflation holds close to target. But, with growth continuing slow, inflation pressures intensifying dramatically and the potential for major policy shifts, the path to bringing down interest rates while maintaining market credibility only gets more treacherous.
Insight by Tom Brown
Global News + ICIS Chemical Business (ICB)
See the full picture, with unlimited access to ICIS chemicals news across all markets and regions, plus ICB, the industry-leading magazine for the chemicals industry.
Contact us
Partnering with ICIS unlocks a vision of a future you can trust and achieve. We leverage our unrivalled network of industry experts to deliver a comprehensive market view based on independent and reliable data, insight and analytics.
Contact us to learn how we can support you as you transact today and plan for tomorrow.
READ MORE
![](https://cjp-rbi-icis.s3.eu-west-1.amazonaws.com/wp-content/uploads/sites/7/2024/01/16170556/ContactUs_Services.jpg)