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The advent of the omicron variant of the coronavirus risks posing new challenges for central bankers by threatening economic growth while adding to inflation pressures.

That’s the initial analysis of economists, who warned that possible new restrictions on activity risk derailing plans to withdraw monetary stimulus while reinforcing the same imbalances that have fueled the current wave of surging consumer prices.

Omicron has hit the world just weeks away from key decisions by global central banks, with the Federal Reserve possibly accelerating a wind-down of its stimulus, the Bank of England potentially about to raise interest rates, and the European Central Bank plotting how to ease the euro zone off of emergency bond buying. They are preparing to respond to soaring inflation, which has reached a three decade high in the U.S., the highest in the eurozone’s history and a 10 year record in the U.K.

Fed Chair Jerome Powell referenced the twin dynamics that omicron presents for the economy in prepared remarks on Monday ahead of a congressional hearing. Omicron poses “downside risks" to employment and growth, but also “increased uncertainty" for inflation, he said.

“It may make central banks question the timing and extent of rate increases, which markets had been pricing in over the next year," said Alex Brazier, a strategist at BlackRock Investment Institute and former senior official at the BOE. “The question is, how much does it delay the restart" of economies, he said. “Delay means weaker growth in the short term, but stronger growth later."

Supply chains

Complicating the decision for policy makers is the risk that omicron leads to fresh curbs in manufacturing hubs such as China, aggravating supply-chain issues, while intensifying labor shortages elsewhere as health fears deter people from returning to work.

Such forces could further spur inflation, which already faces a potential acceleration thanks to robust consumer demand heading into the holiday season, supported by pent-up savings.

On the flip side, disinflationary impulses could include further selloffs in financial markets like the slump in energy prices at the end of last week.

“It’s bad for growth if lockdowns return, but less clear on inflation," said Jordan Rochester, a strategist at Nomura International Plc. “Medium term, it’s not clear it’s disinflationary, given supply chains will struggle for longer, consumer demand remains strong and household balance sheets are stronger than they were in 2019."

Inflation worsens

The inflation picture darkened further on Monday, with Germany reporting that prices surged more than expected in November and Spain registering the fastest rise in the cost of living for almost three decades. Euro-area wide data is scheduled for release on Tuesday.

Even before the new variant hit, Dutch National Bank Governor Klaas Knot alluded to the risk of further price pressures, as he contemplated the potential impact of new lockdowns to contain rising infections.

While the measures “will surely have a moderating impact on economic activity, the impact on inflation will actually be more ambiguous, because it might also reinforce some of the concerns we have around supply bottlenecks," Knot, one of the ECB’s most hawkish officials, told Bloomberg TV last week.

Still, as they assess the outlook with omicron having since emerged, some central bankers sounded relaxed on Monday. Bank of Japan Governor Haruhiko Kuroda said the new variant hadn’t changed his expectation for Japan’s economy to soon return to growth, while Bank of France Governor Governor Francois Villeroy de Galhau said it “shouldn’t presumably change the economic outlook too much."

For Neil Shearing, chief economist at Capital Economics, omicron increasingly looks like a different pandemic shock from the one central bankers were used to.

“Compared to previous waves of the virus, which were on balance disinflationary, a major new wave could now be inflationary," he said.

 

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