Central bank shock potential: Watch out

As the 2008 economic crisis took hold, central banks around the world scrambled to prop up their economies. The result: monetary easing on a global scale.

However there's been fierce debate over whether these stimulus efforts – such as the U.S. Federal Reserve's massive bond-buying program – could have done more harm than good.

David Tice, president of Tice Capital and founder of the Prudent Bear Fund, warned last month that a jolt to international confidence in central banks would lead to a 30 to 60 percent market decline.

We take a look at three of the world's key central banks, and the global risks they pose.


U.S. Federal Reserve
Brendan Smialowski | Bloomberg | Getty Images
U.S. Federal Reserve

U.S. Federal Reserve

The Fed cut interest rates and launched three bond-buying – or quantitative easing (QE) - programs between late 2008 and 2012 in an effort to stimulate the U.S. economy. The move has proved controversial, with some economists arguing that QE was nothing more than a temporary fix.

Now, the Fed is looking to end its QE program with a $15 billion reduction in monthly purchases in October – which, according to some experts – poses risks of its own.

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James Rickards, economist and author of New York Times best seller "The Death of Money", highlighted that when the Fed tapered off its previous QE programs, the stock market and the economy stalled.

"It's happening again, but in slow motion because the QE3 taper was gradual and from a higher level," he told CNBC. "When this third taper is done in November, the weakness will become apparent."

Bank of England

Much like in the U.S., economists in the U.K. are also falling over themselves to predict when the first interest rate hike from its five-year low of 0.5 percent will come. For the first time in three years, Bank of England (BoE) policymakers were split at its August meeting, with Monetary Policy Committee (MPC) members Martin Weale and Ian McCafferty voting for a rise in interest rates.

"The possibility of an increase in the Bank rate is now 'in play'," Investec's Philip Shaw said in a note. "From here on, we might begin to see markets becoming a little jittery over a possible move ahead of each meeting."

Central bank head Mark Carney's reputation was called into question after he unveiled Fed-style forward guidance in August 2013, and said rates would not rise until the U.K. unemployment rate hit 7 percent. This, however, happened much quicker than happened; by April 2014, and Carney was forced to revise his guidance.

For Steen Jakobsen, chief investment officer at Saxo Bank, the BoE's credibility – or lack of it – also poses a risk.

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"Economies are sophisticated," Steen said. "The BoE now needs to provide the market with a more sophisticated response – and there's a risk they won't be successful in this."

Poor communication is very dangerous for central banks, which rely on carefully-crafted statements to guide market expectations. If faith in a central bank's communication is lost, investor confidence could be hit, leading to volatility in stock and currency markets, and uncertainty the broader economy.

Look at FX in world of central bank divergence: Pro
Look at FX in world of central bank divergence: Pro   

European Central Bank

In the euro zone, however, it's a very different story.

At its September meeting, the ECB unveiled yet more stimulus measures designed to bolster the region, where an economic recovery has struggled to take hold. Growth-sapping low price growth has dogged the euro zone, with inflation falling to just 0.3 percent in August and unemployment remaining stubbornly high at 11.5 percent.

The central bank cut its three main interest rates further, and announced it was going to start buying asset-backed securities in an effort to boost the availability of credit. The next step, according to some analysts, is the launch of a full-blown QE program, like that of the Fed's.

Nick Beecroft. chairman and senior market analyst at Saxo Capital Markets UK, told CNBC this will be launched by the end of the year, but added: "the ECB, and specifically the (German) Bundesbank, will have to be dragged kicking and screaming to this".

Andrew Kenningham, senior global economist at Capital Economics,added: "The risk is that they don't do actually do it... There's an element of bluff on the part of Mario Draghi. He can promise to do things, achieve quite a lot just by promising, and then don't have to do it."

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Even if Draghi does launch Fed-style QE, Kenningham questioned how successful it would even be. "It's worth trying, but we're not at all clear it would have a massive effect," he said.

If the ECB doesn't act in the way most expect, markets could be hit hard, as most investors have priced in further stimulus from Draghi. It could also hit the bank's credibility, limiting the power of any future policy announcements.

Be careful what you wish for

One further potential pressure point is a growing divergence between the major advanced economies, with speculation of Fed and BoE tightening as the ECB (and Bank of Japan) inch towards further stimulus.

Currency traders in particular should be watching the situation, Steen warned. The dollar has strengthened significantly against the euro in anticipation of Fed tightening and ECB easing.

But forex markets should be wary on counting on central bank to make the right move.

"I'm perplexed that the market continues to listen to and believe central banks," Steen added. "In the recent past, they have been very wrong."

—By CNBC's Katrina Bishop