MNI: BIS Says Prepare For Tariff CPI Clampdown, Avoid Guidance

Central bank leaders must be prepared to aggressively tighten monetary policy if the U.S.-led trade war boosts inflation, and protect credibility damaged during the Covid price jump by avoiding forward guidance, the BIS annual report said Sunday.

Precise economic forecasts must also give way to alternative scenarios that better show the public heightened uncertainty around trade shocks, according to the institution known as the bank for central banks in Basel, Switzerland. 

"Pandemic-era inflation has made inflation expectations more sensitive," the annual report said. "If evidence of de-anchoring emerges, central banks must respond quickly and forcefully." The trade war and other global forces such as aging populations mean inflation is at risk of becoming more sensitive to even small gains in demand, a phenomenon known to monetary officials as a steeper Phillips Curve, the BIS said.

Central bankers are also under pressure to accommodate elevated government debt and delay Basel III capital rules, the report said. "History demonstrates that any short-term gains come at the cost of long-term instability," said of the Basel III debate. 

Financial markets are already vulnerable as hedge funds play a greater role in government bond markets, the report said, referencing recent weak spots in UK and US bond trading. 

"The new U.S. trade policy, with its unknown eventual scope and impact, has elevated measures of economic uncertainty to levels typically associated with crises and sparked high volatility in financial markets," the BIS said. "As a result, the outlook for global growth has been downgraded, with mixed implications for inflation across economies." (See: MNI INTERVIEW:Tariffs Freeze Fed, Court Global Recession-Fatas)

"Central banks should protect their independence and credibility by remaining grounded in realistic views of what monetary policy can and cannot deliver," the report said. "Forward guidance should be employed judiciously, along with clear communication emphasizing its state-contingent nature and the dependence of future policy paths on economic developments."