A Punch in the Face

Omicron is making all the headlines but inflation remains in the spotlight.

Central bankers are starting to U-turn on their transitory message, including the US Federal Reserve. Clearly, global supply chain challenges have added to the inflationary spike. However, there is a growing risk of inflation becoming more entrenched as wage expectations rise with skills shortages in many sectors.  In the UK, the ‘flawed’ RPI measure of inflation recently touched 6% – the highest level since 1991. Due to be made redundant in 2020, it is probably a more accurate measure of the cost pressure households are currently facing compared to the lower official CPI figure, which itself is twice the level of the Bank of England target.

Regardless of the post-pandemic inflationary spike, should we and central bankers be expecting or forecasting much higher inflation due to the shift to renewable energy? Some global investment banks are suggesting ‘green inflation’ is a real risk. The basic logic is that there is such a shortage of skilled labour in the renewables industries that wages will be pushed upwards. In addition, vast amounts of the renewable commodities such as copper and lithium will be required for electric vehicles and wind turbines suggesting prices will remain high. Bank of America’s chief economist is suggesting that the shift to renewables could add three percentage points to inflation in US alone. Furthermore, he estimates the transition to net zero could cost the world over £100 trillion over the next 30 years!

Environmentalists will no doubt argue this is a price worth paying to save the planet. Some economists also suggest green inflation should not become entrenched as renewable energy will become cheaper and more plentiful in time. However, during the transition to a greener future there is clearly a risk that green inflation will become an additional headache for central bankers. Companies face higher costs for carbon credits and may incur fines if they don’t meet UN climate targets. Companies may look to pass these cost increases onto customers through higher prices.

We now face the additional uncertainty from the Omicron variant which the chief economist of the Bank of England has described as ‘a punch in the face’.

What have we been watching?

Just when it appeared we were over the worst, Covid-19 has returned to rattle global markets. Last week, South African scientists highlighted a new variant now called Omicron. Markets fell at the end of last week as various countries announced travel restrictions, raising fears of more lockdown measures, further supply chain disruption and their impact on global economic growth. On Friday the FTSE 100 suffered its biggest sell-off since June 2020 amid new variant fears.  Over the weekend PM Boris Johnson announced new travel restrictions and a return to mask wearing guidance. Is Christmas safe?

Omicron already appears to have spread across parts of Europe and as far as Canada. In the Netherlands, a KLM flight with 600 passengers from South Africa saw 61 people test positive for Covid-19 and of these 13 had the Omicron variant.

Despite the uncertainty created by the Omicron variant, an element of calm appears to have returned to markets this morning. A South African scientist said that Omicron cases encountered in the country have been ‘extremely mild’ albeit South Africa has a young population. Markets must await analysis regarding the efficacy of existing vaccines against Omicron but the major pharmaceutical companies give the impression that Omicron should be manageable by tweaking the existing vaccines, which like the flu vaccine, would not require further regulatory approval. Perhaps Omicron is a reminder that this is how life may be in the years ahead? Further variants are likely but hopefully should be manageable as vaccines are enhanced to counter them and like flu, annual Covid-19 boosters become the norm as do mask wearing and testing.

The other significant news last week was President Joe Biden’s re-selection of Jerome Powell as Chair of the US Federal Reserve (Fed). Powell’s four-year term was due to end in February 2022 but he will now stay until 2026. The re-appointment of the incumbent Fed Chair marks the return of the approach pursued by new US presidents since 1980 and provides the continuity which markets tend to prefer.

The US Dollar surged to a four -year high against the Yen on Jerome Powell’s re-nomination but also reflecting views that the Fed might tighten monetary policy more quickly.  Jerome Powell said ‘The unprecedented re-opening of the economy, along with the continuing effects of the pandemic, led to supply and demand imbalances, bottlenecks and a burst of inflation. We will use our tools to support the economy and a strong labour market and to prevent higher inflation from becoming entrenched.’  Attention then turned to the minutes from the latest Fed meeting where the pace of tapering QE stimulus is key. Some Fed members noted that ‘the committee should be prepared to adjust the pace of asset purchases sooner than participants currently anticipated if inflation continued to run higher.’  Fed fund futures are implying a 75% chance that the central bank will lift interest rates from historic lows by June next year, up from a 60% chance a month ago.

Inflation remains a headache for all central banks. South Korea’s central bank has put up interest rates for a second time this year to 1%. The bank also raised its inflation outlook from 2% to 2.3% for 2022, suggesting further rate hikes to come. Meanwhile, the Reserve Bank of New Zealand raised its official cash rate by 0.25% to 0.75%. However, central banks now face the added challenge from the Omicron variant. Will this impact global economic growth and dampen inflation with greater consumer caution or will it lead to more lockdowns and exacerbate supply chain disruption?

Geo-political tensions also remain. The risk of a Russian invasion of the Ukraine still cannot be ruled out. Meanwhile, the Middle East remains a tinder box as an Israeli security official was quoted as saying ‘Israel has no interest in a war with Iran, but we will not allow Iran to acquire nuclear weapons. In light of Iranian progress of their nuclear programme, we are preparing for all options and scenarios, including military capabilities.’ Elsewhere, US -China tensions increased after President Joe Biden decided to include Taiwan in the ‘democracy summit’ next month while China has been left off the list.

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In the UK, PMI business activity indicators growth ticked lower in November but only marginally but new orders climbed at the strongest pace since June with respondents highlighting rising client demand on improved economic conditions and a continued boost from the easing of pandemic restrictions. Meanwhile, Sterling strengthened against the Euro as the WHO warned that Europe remains in the firm grip of the Delta variant due to the sluggish uptake of vaccines in some countries.

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Europe was overshadowed by rising Covid-19 cases and by a return to lockdown measures. However, PMI business activity indicators posted a surprising increase in the pace of growth in both the manufacturing and service sectors in November. In Germany, a centre-left led alliance of parties announced a deal to from the country’s new government with the SPD’s Olaf Scholz to be the next chancellor.

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Factory activity in Japan grew at the fastest pace in nearly four years in November. Activity in the services sector also accelerated.

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There was mixed news for China’s struggling property development sector. China is looking to ease fundraising rules for developers but Beijing is also planning a nationwide property tax as part of President Xi Jinping’s ‘common prosperity’ plan. Junk-rated Chinese dollar bonds continued to decline amid lingering concern over a liquidity crisis in the country’s heavily indebted property sector. The People’s Bank of China is continuing to pump liquidity into the system to provide support.

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Brent oil dipped dropped to $76 on the Omicron news. Meanwhile, OPEC+ was reported to be considering revising planned oil production increases if large consuming countries release more crude oil from their strategic reserves or Covid-19 dampens demand in Europe. The US is releasing oil from its strategic reserves in co-ordination with China, India, South Korea, Japan and the UK.

Finally, with so much for investors to ponder on these days, at least we know our country is in safe hands, or is it? For those of us worried that PM Boris Johnson has completely lost the plot, one only has to watch his recent talk to the CBI – Peppa Pig and his missing page of notes … the longest 20 seconds ever? More disturbingly, Boris thought the speech ‘went over well!’


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