Central Bank Credibility Emerges as Risk: ECB Leads, BoJ Lags

Allianz Trade has introduced a new framework to measure central bank credibility, revealing the European Central Bank (ECB) as the leader and the Bank of Japan (BoJ) as carrying the highest overall risk. The analysis also scrutinizes the U.S. Federal Reserve (Fed) and the Bank of England (BoE).

The framework assesses credibility through six dimensions: institutional credibility, expectation credibility, and credibility gap, alongside cyclical factors like credibility risk sentiment, market credibility, and credibility pressure. The ECB demonstrates the strongest performance, which supports the euro's international standing. The Fed shows structural strength but cyclical weakness, while the BoE exhibits structural vulnerabilities.

The report highlights that central bank credibility is shifting from a stable condition to a risk factor. Geopolitical tensions, political polarization, inflation overshooting targets, and high sovereign debt challenge central banks' traditional role as shock absorbers for markets. Instead, these factors may amplify shocks. News-based concern regarding central bank credibility has reached its highest point since 2017.

Allianz Trade proposes four actions to restore credibility: publishing a rule-based framework, anchoring communication to reference points like wage growth, defining the relationship with the Treasury, and establishing a plan for action if rates hit zero again. The aim is to return to absorbing shocks rather than amplifying them.