Omicron variant grinds UK economic activity to near halt

High-frequency data show a severe deceleration of economic activity in the UK as cases of Omicron surge. See what our charts show plus global inflation, US GDP and the relationship between interest rates and inflation.

By 
Julius Probst, PhD
 on 
December 17, 2021

The Omicron variant is causing a surge of new Covid-19 infections daily in both the UK and Denmark despite high vaccination rates.

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Consequently, more people are ending up in hospital, especially in countries where vaccination take-up is comparatively lower, such as those in Eastern Europe. 


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High-frequency data show a severe deceleration of economic activity in the UK as the country returns to partial lockdown. The weekly economic indicator has fallen rapidly and data from restaurant booking site, OpenTable, show a plunge in restaurant reservations in London. The hospitality industry is set to suffer another difficult winter, which will negatively affect economic growth in Q4 2021 and Q1 2022.


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Moving on to the other big topic of the week – inflation.  

In the following chart, we have used IMF data to calculate the proportion of 187 countries within specific inflation ranges. 

As you can see, the number of countries experiencing deflation peaked in 2009, 2015 and 2020 during the first wave of Covid-19. 

However, in the last few months, the share of countries with more than 4% inflation surged to more than 15%, while the share of countries experiencing 2-4% inflation also rose to above 20%.


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The next graph performs a similar exercise using IMF GDP growth data. It shows global growth falling sharply in 2020 with some 90% of countries experiencing a recession due to the Covid-19 shock. We will likely see more than half of the world grow at above 4% in 2021 and 2022, according to IMF projections. 


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The next chart displays the relationship between the output gap (the difference between the actual output of an economy and its potential output) and the inflation gap. Countries that have been growing more strongly over the last year and that have closed the output gap, such as the US, are also experiencing a higher rate of core inflation. This suggests that at least part of the current inflationary surge right now is demand driven.

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This chart shows the relationship between the growth of nominal GDP and household disposable income. Before 2007, the correlation was highly positive, but the pandemic has now completely distorted that relationship, with household disposable income surging thanks to government stimulus even as GDP fell.

The outliers are so extreme that a regression between the two variables from 2007 onward no longer shows a statistically significant correlation.


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This chart shows the relationship between US core inflation (minus food and energy) the 10-year yield. As expected, the regression line from 1990 to spring 2020 shows a tight correlation between inflation rates and nominal yields. After that, the relationship breaks down completely – even as inflation rates rise, yields remained flat. One could thus argue that the Federal Reserve has implicitly put a cap on yields via its asset purchase programme, effectively implementing a form of yield curve control since the start of the pandemic. 

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The last chart shows the FOMC Dot Plot, where each dot marks where a respective FOMC member expects the federal funds rate to be at the end of a particular period. Just this week, the Fed announced that it would taper more quickly and end its asset purchases by March 2022, since inflation rates have recently been much higher than expected. Moreover, the Fed now expects to hike its policy rate three times throughout 2022, which is roughly in line with market expectations. The terminal rate in 2025 is expected to be around 2.5%. Consistent with Larry Summers’ theory secular stagnation, financial markets do not believe that we will go back to a higher interest rate regime any time soon. As the previous chart shows, we will most likely continue to see further outliers in terms of the inflation-yield correlation. 

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