Global Economic Outlook: Ominous Omicron?

The Northern Trust Economics team shares its outlook for key markets in the month ahead.

As the scientific community learns more about the transmissibility and virulence of the new COVID-19 variant, called Omicron, it’s too soon to judge the health implications.  But governments are not taking chances and have started to re-implement public health restrictions to avoid the worst outcomes.  Against this setting, concerns about growth and inflation have risen. 

Our base case anticipates that the initial acceleration stage of the recovery is largely behind us. The exhaustion of pent-up demand should gradually reduce the stress on supply chains.  Workers, sidelined by the pandemic, should continue to return to the labor force.  But the new wave of infections could further disrupt labor markets and the flow of goods. 

We expect growth to exceed its long-run potential rate in major economies, and inflation will remain elevated for most of next year.  This will prompt policy makers to wind down support programs.

This month’s edition offers a deep dive into the U.K. economy, which is battling a fresh wave of COVID-19 infections and lingering consequences of Brexit.  Elements of the British situation may be instructive for other markets. 

United Kingdom

• After registering one of the sharpest economic contractions in its history last year, the U.K. was poised to rebound strongly in 2021. However, the country is bracing for a setback amid new Omicron variant cases.  The government has announced fresh restrictions, which it had long resisted. 
• With early evidence suggesting that Omicron may not be as dangerous as feared, a return to the days of stringent lockdowns and consequent impairment of gross domestic product (GDP) will likely be avoided. The U.K. government’s shift to its Plan B COVID-19 strategy involves relatively minor restrictions and is unlikely to have a substantial impact on economic output.
• Momentum is likely to weaken on the back of greater consumer and business caution, but we expect the economy to continue its strong recovery from the pandemic in 2022. Spending should be supported by piles of excess savings. That said, the level of output is likely to remain below the levels which would have been attained absent Brexit and the COVID-19 shock.
• It’s been almost one year since the start of the Brexit experiment, following the last-minute signing of the EU-UK Trade and Cooperation Agreement. But the process and its aftereffects are still evolving.  The production side of the U.K. economy is in a bad state: Brexit has not only increased the bureaucratic burden on businesses and costs, but has also led to shortages of goods.  Curbs on lower-skilled foreign workers are creating enduring labor shortages in Britain. 
• Negotiations on changes to the Northern Ireland protocol are ongoing with little significant progress thus far. The U.K. has threatened suspension of parts of the agreement, which would spark a trade war with the EU, but given the strong differences in views within the Conservative Party, we do not expect the situation to reach such an extreme.
• Inflation will remain elevated, with the peak yet to arrive. A large increase in energy costs, restoration of the Value Added Tax rate for the hospitality sector, higher input costs created by Brexit, and global supply bottlenecks are all contributing to broad price pressure.  Year-over-year inflation readings are likely to peak around at 5% early next year, before decelerating.
• The British labor market continues to recover, with a steady decline in the unemployment rate. Even though over a million workers were still on furlough when the scheme closed at the end of September, initial evidence suggests that most of these workers returned to their jobs.  This should help ease labor shortages and prevent a sharp increase in the unemployment rate.
• While strong jobs growth and a record number of vacancies were recorded in three months to October, wage growth continued to fall back from its peak earlier this year. Average pay, including bonuses, measured 4.9% higher than a year ago, after peaking at 8.8% during the summer.  Though the underlying wage growth is still well above historical averages, higher inflation prints in the coming months could lead to a further decline in real wages. 
  • At a sectoral level, manufacturing, construction, and services all saw positive but slower wage increases. A similar trend was observed in other areas of economy, like retail trade and hospitality, which had witnessed stronger wage pressures.    
• Renewed COVID concerns had thrown a December rate hike into doubt. But the Bank of England (BoE), ignoring the uncertainty around Omicron, surprised by opting to hike the bank rate by 15 bps to 0.25%. Strong inflationary pressures coupled with tight labor markets strengthened the case for lift off. We now expect two more hikes next year, taking the bank rate to 0.75% by the end of the year. Progress against the pandemic and toward a steady state of trade relations with the European Union will guide the pace of tightening. 
• Fiscal policy played a pivotal role in Britain’s recovery, but is now fading with the furlough scheme and the withdrawal of the temporary £20 a week uplift to universal credit. Realizing the still incomplete and fragile recovery, policymakers set a budget that reduces the scale of fiscal tightening gradually over the next two years.

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