Omicron and 'Plan B'

Three features of this COVID-induced recession stand out. The first is its sheer scale - UK economic output fell by more than 25% during the initial lockdown in March / April 2020, before rapidly recovering to only 5% below its pre-pandemic level by Autumn 2020. In contrast, the impact of the second and third lockdowns was much less severe, with output bottoming out at -8.4% in January 2021 compared with its pre-COVID level. This was in part down to their slightly less restrictive nature, but also due to the improved ability of the economy to cope (for those sectors allowed to operate).

The second hallmark has been the imbalance created between demand and supply, as a combination of changing social distancing restrictions and consumer behaviour has caused rapid swings in demand for some products and services. Supply has struggled to keep up with this shifting demand, as there is inevitably a lag in how quickly production and distribution chains can respond. Brexit has doubtless added to the pressure. When infection rates are high, there is an additional short-term direct effect on supply, as more workers are off sick, self-isolating, or supervising their children at home. 

Some of the COVID-induced shifts in demand are likely to be permanent. The Coronavirus Job Retention Scheme was highly successful at minimising unemployment (peaking at only 5.1%), but some furloughed workers have undoubtedly left the labour market permanently. Shifting demand means there is now a significant mismatch between available skills and job vacancies. The labour market lacks mobility, both in terms of transferring skills and also geographically, and it will take some time for this mismatch to correct itself.

The third feature of this economic cycle is the highly varied, and perhaps surprising reaction of property values. The main beneficiary has been the industrial/distribution sector. Following a brief dip in the first half of 2020, capital values have soared, as distribution played a vital short-term role in maintaining the economy, and the dash towards online delivery accelerated. All-industrial capital values are now 28% above their pre-pandemic level (MSCI Monthly Index, November 2021). 

In the retail sector, the seismic shifts already under way mean that capital values had been falling for more than two years by spring 2020. COVID simply accelerated the falls which would doubtless have occurred anyway. 

The impact on office values has been surprisingly modest given the uncertainties about future levels of office occupancy – although this may partly reflect a low level of investment transactions. Office capital values bottomed out 15 months into the pandemic, having fallen by 7.3%, and have been broadly stable since the summer.

The housing market has also been something of a surprise. Buoyed initially by strong Government support (most notably the Stamp Duty holiday), the official house price index shows that the average UK house price is 16.4% higher than in February 2020, and has increased by 10.2% over the last 12 months (as at October 2021). The desire to live further away from city centres and have more home-office and outside space is undoubtedly a factor.

So far, the latest restrictions are modest (principally working from home where possible; compulsory masks in shops, on public transport and certain other settings; and COVID passes for nightclubs and larger venues). Although the measures chosen can appear inconsistent, they do look deliberately targeted to where there is minimal direct economic impact. Many office workers have continued to work remotely for at least part of the week, and most will readjust quickly. 

However, additional ‘softer’ advice to avoid unnecessary social contact, combined with the more cautious attitude of many people towards social mixing is also having a significant impact. Evidence is already beginning to show that Omicron is affecting consumers, with a downturn in town centre footfall and an increasingly severe impact on hospitality, with falling restaurant bookings and rising cancellations.

The introduction of any further restrictions will depend largely on the number of hospitalisations from COVID and as before, the impact will vary according to sector. Clearly, retail and hospitality are highly vulnerable, whilst the distribution sector would remain highly resilient, and may even benefit. 

Many parts of the economy have become much more COVID-resilient, and a significant further reimposition of restrictions would cause nowhere near the same magnitude of economic damage as previously. Home delivery supply chains have increased capacity and school closures (which impact the availability of labour) are now considered a very last resort. Any further restrictions would inevitably encroach on areas with a greater overall impact on output. However, the largest impacts on supply are likely to be from employees self-isolating or falling ill. This could prove highly disruptive for the next few weeks.

‘Plan B’ may also now adversely affect consumer sentiment more broadly. Confidence was already weak – the GfK consumer confidence index stood at -14 in November, having previously recovered to -7 in July. All this is clearly a major concern for businesses relying on a strong Christmas trading period, and with most specific Government COVID support now unavailable. 

There are some reasons to be optimistic about the level of further restrictions. Government policy is likely to continue favouring a ‘light touch’ approach, as has been the case since the summer, with emphasis placed on personal responsibility. The rebellion by Conservative backbenchers in the House of Commons against COVID passes will also reduce the Government’s appetite for significant further restrictions.

A key concern in recent months has been inflation. Annual CPI has risen dramatically, from just 0.3% a year ago to 4.2% in October and 5.1% in November, well above most expectations. Rising costs, and the shortages of labour and materials that are its underlying cause, are now top amongst the concerns of businesses. Existing upward inflationary pressures could be further exacerbated if Omicron creates more supply chains disruptions (through renewed labour shortages, port closures, or simply consumers once again switching behaviour more rapidly than supply can adjust).

However, there is an alternative scenario. If the impact of Omicron is towards the more severe end of the spectrum, then the associated rapid fall in demand could potentially outweigh the fall in supply by some margin, temporarily reducing inflationary pressures. 

At its December meeting, the Bank of England’s Monetary Policy Committee had to perform a fine balancing act between the risks posed by Omicron and rapidly rising inflation. In the end, it has chosen to raise Bank Rate from 0.1% to 0.25%, judging that the medium-term risks of inflation overshooting its 2% target outweighed any immediate negative impacts on demand.

It is important to remember that today’s situation is very different to that in March 2020. We understand COVID significantly better, vaccines can be tweaked rapidly if required, the infrastructure is in place to administer the vaccines rapidly, and better treatments are available for those with severe illness. In addition, our ability to manufacture vaccines in the UK is being rapidly expanded, including the flagship Vaccine Manufacturing Innovation Centre at Harwell in Oxfordshire, due to start production in the spring. 

Although Omicron will temporarily stall the economic recovery, it should have a much less severe economic impact than previous waves. Government policy this time around is focused towards guidance rather than legal restrictions, we have the ability to rapidly revaccinate the population, and the speed of the current wave means that we should exit faster. The greater economic resilience to COVID impacts will help considerably, and the key risk now is the sheer number of people who could be ill or self-isolating.

The latest forecasts for UK economic growth are buoyant for next year (although they must be seen within the context of making up for the ground lost) - the OECD and the latest Treasury-compiled consensus forecast both suggest 4.7%. Whilst forecasts may be downgraded a little, the economy should still comfortably exceed its pre-recession output level during 2022, unless a prolonged period of much more severe restrictions needs to be introduced. 

As a final thought, even if Omicron’s impact turns out to be modest, it has probably increased the perception that COVID is a long-term issue, with the potential for a cyclical tightening and relaxing of restrictions to cope with new variants. This could filter through in numerous ways, from corporate attitudes to office requirements to demand for more resilient supply chains. 

Businesses, product lines and services cannot simply be turned on and off as restrictions ease or are tightened - companies need time to plan and implement changes, and have the confidence to invest and make contractual commitments. We hope and expect that the additional uncertainly brought by Omicron will be a temporary blip.