Fear inflation... not the variant

THERE is going to be a hit to the world economy from the Omicron variant. There is no doubt about that. Here in the UK, whatever the Government does or doesn’t do, people are going to cut back on their Christmas plans.

Personal prudence, not government edict, will see to that. Pretty much the same is happening in every developed country, with the result that there will be some sort of pause in the recovery.

So what will that mean for us in our daily lives? There will be a bit of a shift in the way we spend our money. Instead of spending more on services – meals out, maybe a foreign trip – we will spend more on things. That is what happened during previous curbs and it will happen again.

But overall we will spend less. That won’t be a catastrophe, but it may mean that instead of the UK economy being back up to its pre-Covid size by now, that will take another couple of months.

Where we may see some lasting effect is on inflation. The more disruption there is, the more prices will climb.

That is happening on a massive scale in the US, where annual consumer price inflation is now 6.8 per cent. That is the highest since the early 1980s – something that has not happened in most people’s working lives.

We get the UK numbers this week, and while I can’t see the Consumer Prices Index getting there, last month’s Retail Price Index was 6 per cent, which is pretty shocking.

Quite what the Federal Reserve and the Bank of England think about all this, we will learn this week when both have policy meetings. They have of course goofed.

Neither of them, nor indeed the European Central Bank, which also meets this week, had any inkling earlier this year of the way in which inflation would race upwards. Eventually, they will have to stop pumping money into the system and increase interest rates. But not yet.

It is even possible that the Bank of England will relax its mortgage lending rules, lowering its socalled reversion rate – the way lenders have to check on whether borrowers could keep up their repayments should interest rates rise.

We already have a huge problem on home affordability in the UK, with the highest ratio of house prices to incomes for more than a century. So what impact would making mortgages easier have on house prices? It would push prices up even more. Oh dear.

So what will happen? The impact of Omicron, or whatever variants follow it, will eventually subside.

Global supply chains will scramble their way back into better order, and we will all get used to not being able to buy everything we want when we want to. Inflation will subside too.

Eventually house prices will plateau, or at least I hope they will plateau rather than crash.

But when some sort of normality returns, will inflation settle around 2 per cent, the target of most central banks? Or 3 per cent? Or 4 per cent, or what?

Think of the social damage caused by cutting the living standards of people on fixed incomes by 4 per cent a year. Or whittling away the value of their savings in a bank by a similar amount.

As for home ownership, over the past 12 months the average house price in the UK has risen by £20,000. So a first-time buyer has to borrow that much more, or save it from taxed income, just to get into the same place as they could have bought last autumn. So what should we expect to happen? The financial markets have taken the Omicron variant in their stride.

Despite the troubling news on the virus, not to mention the political rumpus surrounding the Prime Minister, the Footsie has ended up 2.4 per cent on the week. The S&P 500 in New York and the DAX in Frankfurt were up 3.4 per cent and 3.0 per cent respectively.

Insofar as the markets are worried, their concerns are about the pace at which the central banks will increase interest rates, rather than the speed at which Omicron spreads.

It is easy to see why. If the spread of the virus delays the rise in interest rates, that will help support asset values worldwide – shares, homes, the lot.

The financial markets will continue to party, even if the office parties for the traders get cancelled.

As for the global economy, remember that money not spent now will be money that can be spent later. Right now, inflation looks a bigger threat than the virus.

Money not spent now will be money that is spent later