Central banks, Omicron and the inflation headache

Central banks, Omicron and the inflation headache

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It’s a perilous time for central banks as we head towards the final monetary policy meetings of the year. Just as it seemed banks were gaining the confidence to tackle inflation, the Omicron variant has created a new headache.

We don’t know the seriousness of the new variant yet and scientists are still gathering information about its transmissibility and whether previous antibodies will be effective. The World Health Organisation says Omicron has been identified in at least 38 countries, but we are yet to see any recorded deaths.

For now, we’ll have to wait and see what the new wave will throw at us. Governments across the world are reinforcing restrictions, and the central banks are feeling the pressure.


Out of lockdown

Omicron has created fresh food for thought for central banks. As lockdowns eased around the world earlier this year, central banks kept interest rates low. The shackles were off, and people were encouraged to spend in ways that felt more ‘normal’.

Economies were on their way back. But surging demand from reopening took its toll on supply chains and contributed to the global issues we’re experiencing now. As a result, prices for all kinds of goods ballooned; inflation became the focus.


Inflation in the limelight

Price booms are running wild across the Western World. In the UK, October’s Consumer Price Index (CPI) came in at 4.2%, and the Bank of England (BoE) expects this to continue climbing to 5% next year. On the continent, the EU is experiencing its highest inflation rate since the adoption of the euro – currently reading 4.9%. Similarly, the 6.2% figure in the US is the highest we’ve seen in 30 years.

The challenge for central banks is to determine at what point their economy is healthy enough to raise rates – and risk reducing consumer spending – to help bring prices down.

In recent weeks, we saw the Federal Reserve (Fed) and BoE start to hint at interest rate hikes. The US reported strong inflation data as well as an increase in consumer spending (a 1.3% rise from September to October).

This suggests people in the US have continued to spend despite higher prices. As a result, the Fed’s confidence was up and policymakers began to lean towards higher rates, either at the end of this year or early in 2022.

The Fed and BoE’s hawkish mentalities gave strength to the dollar and kept the pound afloat – especially in comparison to the euro. This was mainly due to the European Central Bank (ECB) insisting that inflation was related to supply chain issues and will gradually sort itself out next year. No rate hikes in Europe anytime soon and the euro felt the full effects.

However, the new Omicron variant of Covid-19 has flipped the script and shaken the currency market. Now, central banks have a brand new challenge. And in many ways, their previous interest rate debates have gone out the window.


Best case scenario

What we do know about the Omicron variant is that it’s mutated significantly from the Covid variants we’ve dealt with previously.

Central banks will be hopeful that the new variant struggles to beat the vaccines, results in mild symptoms and has no long-term effects. If so, we might view it as a new form of seasonal flu which society should be able to handle.

If this is the case, the Fed, BoE and ECB will be granted the magical gift of time – something they’ve been deprived of for the last 18 months or so.

It means they can evaluate the effect of easing supply chain issues on inflation and whether rate hikes will be needed. The decisions will be made significantly easier without the fear of future lockdowns.


Worst case scenario

On the flip side, if the concerns about Omicron’s contagiousness turn out to be true – and it brings a dangerous set of vaccine-proof symptoms – we might see worldwide lockdowns and panic to create all-new vaccines.

If this becomes our reality, workers will go back to staying at home – exacerbating supply chain issues and potentially sending prices through the roof. Not a good situation for policymakers.

From what we’ve seen before, lockdowns can cripple economies. The US and Europe are desperate to avoid lockdowns where they can, but some countries seem to have no choice. Austria has already enforced lockdowns and Germany is treating its current wave as a national emergency.

What’s more, European nations such as these are currently fighting the Delta variant, with Omicron only just making itself known.

Whatever the result of the new variant, we’ll likely see some rethinking in our approach to Covid-19. The virus hasn’t gone away and the lack of vaccination worldwide leaves us exposed to more mutations.

The way central banks manoeuvre the next couple of months will be crucial. Only time will tell what the next policy meetings will produce and how Omicron will play its part.

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