How might Omicron impact the outlook?

We therefore find it too early to make any changes to our key economic and market calls. However, below we give an insight into five of the key questions that arise and subsequently set out some stylised scenarios.

How dangerous will the Omicron strain be?

Three factors will determine this: a) is it more transmissible? b) does it evade vaccine protection? c) does it cause more severe disease?

Our take from the reports and expert opinion so far is that Omicron looks likely to be more transmissible and resistant to vaccines, but the biggest question mark remains on the severity of the disease. The latter could prove to be crucial – if it is as severe or more severe, policymakers may need to reimpose lockdowns (see also below). If the disease is less severe, the new variant could even be a positive development, as a more benign virus would supersede a more dangerous one (Delta).

To more specifically answer the above questions: a) The fact that Omicron so rapidly became the dominant strain in South Africa (now making up >75% of cases) suggests that it may be more transmissible than the Delta variant. b) The number of mutations suggests potential for significant vaccine evasion. An earlier study referenced by the ECDC involving a synthetic variant with 20 mutations showed almost complete vaccine evasion; Omicron has over 30 such mutations. c) It remains unclear whether Omicron causes more severe disease. Early anecdotal reports suggest mild disease, but most cases have been in young healthy adults.

How quickly could a new vaccine be put in place?

One of the advantages of the modified mRNA technology that is used to build many Covid-19 vaccines is the ability to reprogramme the vaccines relatively quickly to counter dangerous new mutations. Indeed, Moderna’s Chief Medical Officer Paul Burton asserted over the weekend that ‘If we have to make a brand new vaccine, I think that’s going to be early 2022 before that’s really going to be available in large quantities’. Similarly, Pfizer and BioNTech expects ‘to be able to develop and produce a tailor-made vaccine against that variant in approximately 100 days, subject to regulatory approval’.

It therefore seems that new vaccines would be available at some point during Q1, though rolling them out to a significant proportion of the public may take several more months. Even assuming speedy roll-outs across the richer economies, it must be noted that up until now, vaccination rates have been uneven and very low across much of the developing world. The emergence of Omicron adds to the case that ‘nobody is safe, until everybody is safe’.

How would demand be impacted?

The demand effects are likely to differ significantly between the eurozone and the US, and between goods and services. The eurozone is more likely to see a bigger hit to demand in a negative scenario than the US. In the eurozone, renewed lockdowns would trigger significant declines in services consumption, and likely a minimal impact on goods consumption. A technical recession is possible, depending on the length of lockdowns. In the US, lockdowns (and their recessionary effects) are likely only in a very negative scenario, where policymakers are much more reluctant to impose restrictions on activity, and healthcare capacity buffer appears to be greater. In the US, a bigger effect could be on the composition of consumption, with the services recovery facing a further delay, and goods consumption likely remaining above trend. Such an effect was observed during the Delta wave over the summer months; there were no new restrictions on activity, but consumers stayed at home more and goods consumption stayed well above trend.

Could Omicron exacerbate supply issues and therefore inflation?

The supply side looks very likely to be adversely impacted if Omicron proves to be a more dangerous strain than its predecessors. Manufacturing and transportation could be impacted by a combination of direct restrictions and the disruption to labour supply. The zero tolerance policy of the authorities in China and some other Asian countries certainly points in this direction. Of course this would come at a time where the various supply-side bottlenecks globally are already severe, with long delivery times and a record gap between orders and output in major manufacturing economies such as Germany.

The overall impact on inflation will likely differ by sector and by country. A short-term significant disinflationary impact could come from oil prices. The quickest and most restrictive measures would likely be seen in travel, while any restrictions on mobility could also hurt demand for oil. On the other hand, it will be crucial how OPEC+ respond in terms of the supply side. Meanwhile, given resilient demand for manufactured goods, and forces to constrain supply, inflationary pressures could persist and even intensify in this sector. On the other hand, the demand shock may overwhelm the supply shock in services, leading to lower price pressures. Finally, countries that go into the ‘Omicron shock’ with stronger demand and close to full capacity (the US) are more likely to see more inflationary pressure, while those with weak demand and slack (the eurozone) could tend towards disinflation.

How would policymakers respond this time?

The policy response is likely to be more restrained in terms of size and more focused on cushioning the supply side than fuelling another surge in demand. This follows from (a) the lessons from earlier policy measures (b) a different starting point in terms of inflation (c) limitations from using a lot of firepower over the last two years. For instance, the US government is unlikely to use the approach of sending significant transfers to households, while boosting unemployment benefits to levels that in some cases exceeded in-work income. This had the effect of both turbo-charging demand and limiting labour supply. The European approach of in-work support might be preferable, though it can have the side effect of creating rigidities. Meanwhile, the Fed will be constrained by worrisome inflation trends. High government debt levels, without a big buyer of Treasury securities may also restrain the extent of the fiscal response. In the eurozone, the ECB will likely be less constrained by inflation concerns, though it may not feel the freedom it did in 2020 where the starting point for underlying inflation was much lower. In addition, while the PEPP is not officially constrained by issuer limits, the 50% threshold may still provide some constraint. (Nick Kounis, Bill Diviney, Aline Schuiling)