How will Omicron impact central banks’ decisions?

Mr. Michael Saunders, an external member of the Bank of England's Monetary Policy Committee said that the Omicron variant of coronavirus does provide some justification for delaying a rate hike. 

Last week, we heard ECB President Lagarde suggest that now might not be the right time to make longer-term policy commitments given all the uncertainty. At the same time, Mr. Hawk Saunders, an external member of the Bank of England's Monetary Policy Committee said that the Omicron variant of coronavirus does provide some justification for delaying a rate hike. But from the Fed, everyone from Chair Powell downwards seems to be sticking to the script that the taper should be speeded up so that, in Powell’s words, it can conclude “a few months sooner”. Mr. Steve Barrow, Head of Standard Bank G10 Strategy, said this is the right decision. Not because he is sure that Omicron will prove less potent than policymakers might be fearing at the moment. Instead, it is because the Fed desperately needs to give itself the option to hike rates quickly.

“We have argued many times before that one of the worst things a central bank can do is to put themselves in a position where they are effectively unable to change policy. This is where the Fed seems to lie at the moment because it has been arguing that rates won’t rise before the taper is done. And as that’s currently scheduled to last until June it means more than six months with the Fed’s hands tied behind its back. Of course, we don’t doubt that, if push came to shove, the Fed would hike rates while still buying assets, but it would be an incredibly hard measure for the Fed to explain and would surely risk a massive and disruptive decline in asset prices. We’ve seen in the past how even small tweaks in the Fed’s guidance can move markets abruptly. Hiking rates while still buying bonds would be a huge volte face and one that surely would have such significant consequences that the Fed would be very reticent to do it in the first place. This is not a good position for the Fed to be in”, Mr. Steve Barrow said.

Meanwhile, the Bank of England seemed to realise this problem very early on and it has been very forthright in declaring that it could hike the base rate in the midst of buying gilts. Of course, the Bank did not deliver on a rate hike at the November meeting when many expected that it would (and when it is still buying gilts). But that’s not the point. The point is that it gave itself the option to hike; something that the Fed seems to have disallowed. The problem for the Fed is that the data on inflation has simply not given it the space to maintain such a position. Hence it needs to speed up the taper for, as we argued some months ago, it is the end of the taper that is important, not the start. Even bringing the end forward a couple of months might not prove sufficient and we’d fully expect more speeding up in the future to try to reduce the period of tapering by as much as the market will bear.

Undoubtedly, the Fed will be looking at data at the same time; both on the economy and on Omicron case numbers. But Mr. Steve Barrow does’t think that adverse trends on either of those is going to knock the Fed out of its stride on tapering, even if these trends do ultimately end up pushing back the time at which the Fed starts to lift rates. The bottom line is that he does not think that the market should take the Fed’s determination to taper faster as a hawkish message but, instead, a desire for optionality on rate policy. “If that’s correct, we don’t see why this apparent gap between Fed policy on one side and BoE/ECB policy on the other should necessarily lift treasury yields much more than gilt/EGBs, or boost the dollar materially. The Fed is just setting itself up to be in a better position to lift policy rates more quickly; it does not mean that it will do so”, Mr. Steve Barrow stressed.