Central banks that worked hand in hand with governments to contain the financial crisis may succumb to political pressure and delay unwinding ultra-loose monetary policy, risking igniting inflation and speculative bubbles.
With the worst of the turmoil over, central banks have started looking at raising interest rates and ending emergency measures, but a debate still rages on how and how soon to do it as the world economy pulls out of its worst downturn in generations.
Many governments are now exploiting that uncertainty and pressuring central banks to stay put, afraid that tightening will strangle fragile recovery and raise the cost of financing deficits that have ballooned as a result of stimulus spending.
The severity of this crisis and the constant reminders of historical mistakes perceived to have been made in the U.S. and Japan of tightening too early, would seem to translate into higher risk of governments pressuring central banks not to repeat that mistake. said Kirby Daley, senior strategist at Newedge Group in Hong Kong.
With so much remaining uncertainty as to the sustainability and, indeed, the reality of the current 'recovery' central banks will be more likely to err on the side of too loose for too long.
Inflation is still very low in most places, but warning signs are already flashing: stock markets are rallying, energy and commodity prices climbing, and economies in Brazil, China, India and other emerging markets are bouncing back.
Global stocks scaled one-year highs this week, while house prices are also rising in Hong Kong, South Korea and Australia, which this month became the first major economy to raise interest rates since the collapse of Lehman Brothers in September 2008.
Many governments, however, insist it is much too early to call off the state of economic emergency and lean on central banks to prevent them from following Australia's example.
The first to feel the heat are central bankers in economies that weathered the downturn reasonably well and those with a history of close consultations between government officials and monetary policymakers -- many of them in Asia.
In Japan and South Korea central banks recently surprised markets by stepping back from announcing tightening steps, which coincided with government warnings that they threatened to derail fragile recovery.
In India, the central bank is expected to keep rates steady at its quarterly review on October 27 accompanied by a chorus of top officials pleading for the extension pro-growth policies until full-fledged recovery is secure. That worries some analysts, concerned that the authorities will be slow in countering a forecast surge in inflation.
COLLABORATION OR PRESSURE?
Countries that acted less aggressively during the crisis will have an easier time getting back to normal, while developed nations, such as the United States, will have to move slowly, said Glenn Maguire, chief Asia economist at Societe Generale.
Ultra-loose policies are expected to prevail well into next year and beyond also in Japan, the euro area and Britain. There analysts expect close cooperation between central banks and governments in crafting rescue packages to extend to exit strategies, though they may still disagree on timing.
The global coordination on policy aimed at dealing with the crisis has from the start been led by governments, said In-sung, an economist at Samsung Economic Research Institute in Seoul.
Central banks in some countries are talking tough on policy, but I don't think they will lead the process.
In Britain, the authorities appear to agree it is too early to roll back the economic stimulus and earlier this month the central bank kept its 175 billion pound ($287 billion) asset purchase scheme made up of government bonds, or gilts, intact.
It remains to be seen how the exit strategy will pan out but generally the BoE's interests and the government's interests are fairly similar and I think it unlikely that they will want to sell gilts back aggressively, said George Buckley, chief UK economist at Deutsche Bank.
In the euro area, the European Central Bank, highly sensitive to any signs of political pressure, is taking no chances and has gone on the offensive, calling on governments to bring budgets back in line after the crisis spending spree.
The need for ambitious and realistic fiscal exit and consolidation strategies is becoming increasingly pressing, ECB President Jean-Claude Trichet said after the bank's October 8 policy meeting.
Elsewhere, strengthening economies and looming inflation could put central banks on a collision course with politicians.
In my view central banks in Asia have always been less independent than their peers in the West, and in an extreme scenario like this I would always expect governments to exert considerable pressure, said Frederic Neumann, Asia Pacific economist with HSBC in Hong Kong.
But some emerging markets central banks appear both determined and well placed to stand their ground.
South Africa's central bank, for example, rebuffed calls from unions for looser monetary policy, while in Brazil the central bank chief's inflation-busting fame made markets factor in a slight chance of a rate rise already in December.
While Brazil's Finance Minister Guido Mantega has dismissed fears of economic overheating and said there was no need to raise rates, governor Henrique Meirelles' track record -- he tamed the country's hyper-inflation -- makes it unlikely that he would cave in to pressure.
If rates need to be raised, no one's tears will prevent it, said Zeina Latif, chief Brazil economist at ING in Sao Paulo.