Swhere we are again. Christmas is approaching and a new variant of Covid-19 has appeared. Infections are on the rise but the government fears an overreaction. There are public health risks from socializing people, but economic risks if they don’t. Being a chair critic is easy, but finding the right balance is difficult.
A few weeks ago, everything was different. True, the number of cases in the UK remained stubbornly high, but the UK was not suffering from the spike in cases seen in Austria, Germany or the Netherlands. The arrival of vaccines – the big change in the past 12 months – has meant hospitalizations and death rates were far lower than they were when the country was locked down last winter.
Meanwhile, the economy was advancing. The end of the holiday went without the dreaded wave of layoffs and things were improving in both manufacturing and services. The industry had the strongest order books since the late 1970s, while the easing of travel restrictions meant the service sector saw the strongest recovery in overseas business in four years.
Growing inflationary pressure caused by supply-side bottlenecks was the biggest obstacle to rising output, and the City was confident that the Bank of England’s monetary policy committee would raise rates of interest at its December meeting.
Then Omicron arrived and everything got very complicated.
For starters, the new strain of the virus is already having an impact on the economy. People work more from home and go out less. In a milder form of the behavioral pattern seen during shutdowns, people will instead spend money that would have been spent on services on goods. There will be fewer visits to theaters but sales of new televisions will increase.
It was this change that created global bottlenecks, as supply could not keep up with demand. Until a few weeks ago, consumers and businesses began to feel the end was in sight: that once the Delta variant was removed, life could return to its normal course. This idea has now been rejected, because even if Omicron turns out to be less of a problem than feared, there will be more Greek letters to come, one of which could be a super-variant. What were originally seen as temporary behavioral changes may become more entrenched. Inflationary pressures perceived as transitory could become more permanent.
For the Bank of England, as for other central banks, this poses a dilemma. The MPC delayed the rate hike last month because it wanted to see the unemployment impact of the end of the holiday. Should it take a wait-and-see approach again until it becomes clearer how serious Omicron will be for the economy, or does this risk requiring tougher measures in the future? Michael Saunders, one of two MPC members who voted for a rate hike in November, presented both sides of the argument in a speech last week.
Judging by his recent remarks, former Threadneedle Street boss Lord King would have no hesitation in voting for a rate hike if he was still governor. Speaking recently, King said central banks took a King Canute-like approach in which inflation would stay low because they said so.
When he was governor, Mervyn King coined an acronym for the state of the economy: Nice. It represented continuous non-inflationary expansion and summed up the seemingly benign state of the world as it was in the early years of the 21st century.
Nice times have never been as good as they looked, but even so things were a lot simpler back then. The economies have grown steadily year after year, inflation has remained low, and central banks have contented themselves with adjusting interest rates from time to time.
There is nothing central banks would love more than to return to the era of Great Moderation of the late 1990s and early 2000s. But those days are over, if not forever, at least for a long time to come. .
While the stakes are high for the Bank of England, they are even higher for Boris Johnson and Rishi Sunak. The Prime Minister and the Chancellor have their differences but they agree that the UK must learn to live with Covid, and that vaccines make it easier to adapt. Since the end of the summer, the Treasury has acted as if the crisis is all but over: ending support schemes such as holidays and focusing on reducing the budget deficit.
The first signs from the job market are encouraging. Unemployment has not increased and there are many vacancies. People wanted to get their lives back on track after more than a year of severe restrictions on their personal freedom and flocked to pubs, restaurants, hotels, theaters and cinemas that reopened. Activity was buoyant in the sectors most affected by government restrictions.
As with the Bank of England, the government faces a dilemma, but with potentially much more serious consequences. Would it be better to take a risk-free approach for Omicron by introducing more stringent restrictions now or just wait and see how things unfold?
Despite mixed messages from Westminster and Downing Street last week, the opinion appears to be that economic disruption should be kept to a minimum and that Christmas should not be canceled for a second year in a row. The high bar has been set to impose further restrictions.
The risk, of course, is that Omicron will spread quickly and that tough restrictions will eventually be imposed anyway, causing strain on both the NHS and the economy. For an already weakened government, such a double whammy would be potentially catastrophic.