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What could Omicron mean for UK economy?

What could Omicron mean for UK economy?

As various parts of the world embrace, to varying extents, new pandemic restrictions, investors must also question a range of assumptions around the economic outlook. 

In the weeks prior to the announcement that a new, potentially more virulent strain of Covid-19 had emerged, the market was fixated on the question of inflation and of when and to what extent monetary policy would be tightened around the globe to combat this. 

Prior to the pandemic, the advent of restrictions on people’s ability to consume, work and travel would have been viewed by the majority of market participants as distinctly deflationary events, with the level of demand in the economy falling. 

The shock for policymakers in 2020 was that demand held up better than could have been expected, with consumers embracing online shopping and workers proving productive at home. 

Demand holding up better than expected was met by supply problems, as companies, anticipating a much worse outlook for demand than happened, had cancelled production or manufacturing orders, contributing to subsequent supply shortages, which created supply side inflation. 

With economies far more used to remote working, there is arguably greater certainty around the levels of demand amid Omicron, but across the range of possible scenarios, there is also a greater level of certainty that inflation will persist, says George Lagarias, chief economist at Mazars.

He says: “There is a six in 10 chance that Omicron is a negative for both growth and inflation. On the inflation side, it’s important to realise that 6/7ths of the world’s population is not vaccinated. And those people are mostly in the areas where the global supply chains are, so the likelihood is that, whatever happens to demand, supply chains will be impacted, and they were pretty beaten up already, and that will mean supply side inflation.”

Inflation nation

David Miller, executive director at Quilter Cheviot, is more sceptical that the new variant will create a further bout of supply side inflation.

He says: “I was amused to read a well thought out report linking the emergence of the Omicron variant to higher inflation. The argument went as follows: as restrictions are reimposed we will spend less on services, for example going to restaurants, and go back to buying goods for use at home, thus exacerbating supply chain shortages. All entirely possible, but too clever by half I suspect.”

Lothar Mentel, chief investment officer at Tatton Asset Management, takes the slightly different view that supply chains issues had begun to improve in recent months, and this could lead to the type of inflation we have experienced of late changing, albeit with inflation remaining high. 

He says: “Despite expressing concerns about the inflation outlook, [we] are of the opinion that supply chain issues may be fading. Since October, ocean container shipping costs from Shanghai to Europe are down by more than 6 per cent, and from Shanghai to US ports by more than 20 per cent, [according to the World Container Index].