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Economy in Brief

Assessing the Omens from Omicron
by Andrew Cates  November 30, 2021

What impact will the new Omicron variant of COVID-19 have on the world economy? That's a question that's naturally being asked at present, not least in financial markets. But the truth of the matter is that we just don't know. The evidence that's available so far suggests that it is a highly contagious variant. But no-one knows yet whether it increases morbidity, the risk of death or hospitalization or whether it meaningfully reduces the efficacy of existing vaccines.

So what do we know at present that might be relevant for assessing the balance of risks?

Let's start with the good news. Prior to the discovery of Omicron the risk of death from COVID had fallen to its lowest level since the Pandemic began. That is the message from the global dataflow for new cases and new deaths and a comparison of the ratio between the two (see figure 1 below). This reduced risk can be traced to the immunity that's been built up by the combination of prior infection, vaccination along with better drugs to treat harsher symptoms.

Figure 1: The global risks of dying from COVID appear to have declined

The efficacy of existing vaccines is particularly encouraging. The evidence for this is now far-reaching but it can be seen at the cross-country level in the figure below contrasting vaccination rates in the G20 with recent changes in their COVID mortality rates. Those countries with high vaccination rates have seen relatively low mortality rates in recent months while countries with relatively low vaccination rates – including South Africa – have seen higher mortality rates.

Figure 2: Higher vaccination rates are associated with reduced mortality in the G20

Source: University of Oxford/Haver Analytics

So that's some good news and it should mean the world economy is in a considerably stronger starting position to cope with this new Omicron variant relative to prior strains and in particular the Delta variant. More fundamentally at the macro level and while we're thinking about the positives it's worth adding too that household balance sheets are in reasonably good shape and that global monetary and financial market conditions remain very accommodative.

There are, however, several negative features of the global environment at present that suggest a cautious take on the global economic and financial market outlook may now be more apt.

The first concerns Europe where surging COVID case numbers in recent weeks have left some countries much more vulnerable to economic setbacks. Over the past couple of weeks, governments in Belgium, Germany, the Netherlands and Ireland have tightened restrictions with Austria going one step further in re-imposing an economy-wide lockdown on November 22. As a result of this, mobility has waned quite sharply, which is jeopardizing economic activity particularly in service-producing industries (see figure 3 below). The new Omicron will surely exacerbate these trends and potentially inflict more damage on the service sector via its likely impact on travel, tourism, leisure, and hospitality.

Figure 3: Ebbing mobility trends in Europe

The second feature concerns the broader threat to global growth that's been generated by higher inflation. A flurry of negative global data surprises and downward revisions to GDP forecasts (see figure 4 below) suggest that global growth momentum has been weakening now for several months. Much of this weakness can be traced to supply-side congestion and higher inflation. And Omicrom may well exacerbate the downside from these factors in the period immediately ahead. Supply-chain congestion is certainly less likely to ease and cost and price pressures from shortages and bottlenecks are more likely to climb.

Figure 4: Consensus GDP forecasts for 2022 in many large economies have been downgraded in recent months

The starting position for financial market valuations is not that positive either. Global equity market valuations still look quite rich, for example, relative to both their recent multi-year averages and the evolution of the incoming economic dataflow (see figure 5 below). Bond markets in the meantime have been grappling both with the scourge of inflation (see figure 6 below) and with policymakers that have been a little more keen of late to normalise monetary policy.

Figure 5: Global equity market valuations are quite high

Figure 6: Inflation expectations are high relative to the evolution of global growth

All this moreover naturally leaves Central Banks in a major bind. Staying the course and raising interest rates to higher levels and/or tapering asset purchase programmes could further derail economic growth but – given its supply-side roots - do very little to throttle inflation. And for policymakers more generally marshalling the levers of fiscal policy once again from already uncomfortably high government debt levels is not an easy option either.

So while we don't know that much about the Omicron variant yet what we do know is not that positive. From a healthcare perspective the world is almost certainly in a much stronger position to cope with the variant. But having already shifted to the negative side of the ledger, the balance of risks to the global economic outlook has arguably shifted a little further to the downside.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

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