Signed into law last August by president Joe Biden, the US Inflation Reduction Act has become a source of friction with the EU as European investors become distracted by new opportunities emerging on the other side of the Atlantic.

Backed with a $369bn budget for climate action in the form of grants, tax credits and loans, the legislation is designed to support renewable energy, carbon capture, electric vehicle and climate-friendly agriculture projects, along with home energy efficiency for consumers, creating up to nine million jobs by 2032 and slashing the country's carbon emissions.

However, it has raised hackles in the EU, where its subsidies to US industry are seen as anti-competitive and a threat to trade on two separate counts – by making US products cheaper than European alternatives, and by attracting sustainable finance from European investors who might otherwise support domestic initiatives.

Having listed the EU’s various complaints in a comment by its delegation to the US government in November, European leaders have since floated the possibilities of either responding in kind to the legislation with similar EU measures, or relaxing existing rules on state aid. Neither has yet won a consensus.

For the former, the call by France's president Emmanuel Macron for a European financial support programme has yet to gather significant adherents amid inevitable questions about where to find the money for additional spending amid a likely recession and high inflation, and how the programme would be administered. However, the proposal will be discussed during a special EU summit in Brussels on February 9 and 10.

The idea of relaxing state aid rules has been criticised by Belgium's prime minister, Alexander De Croo, and academics in Germany who argue that easing restrictions on state support would favour member states with the deepest pockets and that the EU’s true strength lies in collaborative action.

Given Biden’s determination to establish the US as a leading player in the green economy and to deliver positive outcomes for under-pressure US workers and consumers, any major revision of the legislation is unlikely despite pressure from the EU.

However, Washington has no desire to start a trade war with the EU, either. The establishment in October of a joint EU-US task force to deal with the fallout from the Inflation Reduction Act sent a clear message that some tweaking of its provisions would be possible – a view vindicated by the US decision in January to allow EU companies to benefit from the legislation's Commercial Clean Vehicle Credit scheme. A welcome victory, the EU doubtless hopes it will be the first of many.

An emphatic rejection by US Federal Reserve chairman Jerome Powell of using monetary policy to support environmental goals has exposed a clear divide among the world’s leading central banks over their response to climate change.

“We are not and will not be a climate policymaker,” Powell told a meeting of central bankers organised by Sweden's Riksbank in Stockholm, arguing it would be inappropriate for the Fed to use policy tools its promote a green agenda "without explicit congressional legislation".

His concern about the Fed's mandate is a significant one, given Republicans' narrow victory in the House of Representatives’ mid-term elections in November, many of whom strongly oppose what they consider to be the “woke capitalism” of ESG investment.

Powell's speech also underlined a sharp contrast between the positions of the Fed and the European Central Bank. Last July, the ECB announced that climate change considerations would henceforth be incorporated into its monetary policy framework, enabling it to deliver on both its primary role of delivering price stability and its mandate from the EU to support the green transition.

Speaking at the same event as Powell, ECB executive board member Isabel Schnabel did acknowledge the primary role of governments in curbing global warming, insisting that “fiscal policy needs to remain in the driving seat when it comes to fighting climate change”.

However, she argued that the ECB should step up efforts to make its monetary policy more climate-friendly, possibly by harnessing its multi-trillion-euro stockpile of bonds. "It would be misleading to use tighter financing conditions as a scapegoat for further delays in the green transition," Schnabel told fellow central bankers.

However, she received immediate pushback from Pierre Wunsch, governor of the National Bank of Belgium and a member of the ECB's governing council, who insisted that it was the job of governments to combat climate change and that the ECB should not be correcting the failure by others to act: "By saying we have a role in helping to finance the green transition, we are increasing this misunderstanding of what our role is."

The lack of a clear consensus is also reflected in the nuanced positions of other central banks. While the Bank of England said in June that part of its mission was to manage “the financial risks and economic consequences arising from the physical effects of climate change and the transition to net zero emissions”, governor Andrew Bailey told the Stockholm meeting that it would not make interest rate decisions based on their potential impact on climate change.

Bank of Japan governor Haruhiko Kuroda was similarly equivocal, pointing out to delegates that central banks cannot “unconditionally respond to climate change”. However, he added that the central bank adopted climate change measures that were aligned with policies of the Japanese government and were “generally accepted by the public.”

Central banks clearly have a role to play in climate strategy; the real issue is the extent to which they feel empowered to do so by political authorities. Claudia Buch, vice-president of the Deutsche Bundesbank, argues that “price stability and financial stability are important preconditions for sound investment and economic decisions” and that both fall within the mandate of a central bank - a view shared by Banque de France governor François Villeroy de Galhau.

However, while some room for manoeuvre exists, the task would certainly be a lot easier if central bankers were confident that they and national politicians are on the same wavelength.

The successful issue of €1bn of sustainability-linked bonds by Air France-KLM in January and the similar popularity of the world’s first sustainability-linked sovereign debt issued last year by Chile and Uruguay have underlined the instruments' surging popularity. From just $9bn issued worldwide in 2020, Moody’s estimates the figure for 2022 to have soared to $150bn.

With the bond's interest rate tied to achieving pre-determined sustainability targets, the aim of sustainability-linked bonds is to encourage a company or government to decarbonise without having to define a specific ‘use of proceeds’ - unlike the issue of green bonds for construction of a wind farm, for example. However, the metrics can vary enormously and some critics argue that the targets are often insufficiently demanding.

For Air France-KLM, whose bonds were 2.6 times oversubscribed, the coupon is indexed to a target of reducing its scope 1 and 3 life-cycle emissions for jet fuel by 10% per revenue tonne-kilometre by 2025, starting from a 2019 baseline. Some sceptics are disappointed by those relatively modest performance thresholds and the fact that the primary purpose of the proceeds is not to accelerate the shift to a lower-emission airline industry but to pay off part of a Covid-19 loan from the French government.

By contrast, the first sovereign issues look closer to public expectations about financial tools to boost the energy transition. The aim of Chile's $2bn bond is to finance an increase in the proportion of the country’s energy generated from renewable sources to 60% by 2032, up from around 33% today, entailing a reduction in carbon emissions.

Uruguay’s $1.5bn issue added an extra tweak to the formula by providing for not only a step-up in the interest payable if targets are not met, but also a reduction if the country outperforms against a pre-determined threshold. Its targets for the end of 2025 are a 50% reduction in greenhouse gas emissions per unit of GDP from a 1990 baseline and maintaining the same level of forested areas as in 2012. Undeterred by the potential reduction in returns if the government meets its targets, the issue in October was four times oversubscribed.

In Europe, the market includes institutions such as the European Bank for Reconstruction and Development, which has invested in corporate sustainability-linked bonds issued in Croatia, Lithuania and Poland over the past year, while the European Central Bank has accepted such bonds as collateral for its asset purchase programmes since January 2021.

However, concern remains among some investors that sustainability targets are often relatively easy to meet. Their scepticism is shared by Eila Kreivi, chief advisor on sustainable finance at the European Investment Bank, who praises the International Capital Market Association for trying to make the target-setting process more rigorous in June, warning that a small contribution to the EU’s environmental objectives “is fine, but it’s not enough”.

A report in October by the London-based Bureau of Investigative Journalism and UK broadcaster BBC accused HSBC of helping to structure sustainability-linked bonds that have provided $2.4bn in financing for fossil fuel, deforestation and air travel projects, complaining that the bonds are “a way for companies to give the appearance of environmental concern while continuing to worsen the climate crisis".

The decision by Singapore energy company Sembcorp to sell its Indian coal-fire power plants to avoid paying higher interest on its sustainability-linked bonds - while continuing to finance the assets for the next 15 years - also raises questions. The $1.5bn sale to an Omani consortium enabled Sembcorp to reduce its carbon dioxide equivalent per megawatt hour from 0.51 tonnes to 0.32, well below the bonds' target of 0.4.

As in many other areas of the industry, it will be down to asset managers, institutional or individual investors to look carefully beneath the hood of green investment instruments before deciding whether they should hop aboard.