One must feel for central bankers trying to make policy two years out when there are multiple unknowns that significantly influence monetary policy decisions and outcomes.
The Omicron variant of Covid-19, which the brilliant South African scientists first detected and reported two weeks ago, is likely to be a pain for the Reserve Bank as it prepares for its January monetary policy committee (MPC) meeting.
Developments in the past two weeks have immense implications for how the global and domestic economies will evolve.
Omicron is reported to have the highest number of mutations among variants so far, bringing significant uncertainty to economic expectations for 2022. Much remains unknown; thus, no-one should be changing economic forecasts until more information on transmission, hospitalisation and disease severity becomes available.
That said, four scenarios might play out.
Developments in the past two weeks have immense implications for how the global and domestic economies will evolve
First, Omicron is highly transmissible, wears down immunity but results in relatively mild symptoms and less hospitalisation. In this scenario, lockdown restrictions will intensify but remain modest relative to the third wave.
As businesses are mildly restricted, the demand for labour, services and goods declines, leading to lower economic growth and employment losses. The inflationary consequences remain uncertain as services inflation declines while goods inflation increases due to constrained supply.
In this scenario, the Reserve Bank should wait and not rush to normalise policy.
Second, Omicron is highly transmissible and causes severe reduction in immunity, and symptoms that require hospitalisation. This is far worse than the first scenario and results in lower demand for goods, services and labour as greater restrictions will be required.
Growth slows but the impact on inflation remains uncertain. This scenario also requires monetary policy to remain accommodative, provided inflation is well contained, as is the case currently.
The third scenario involves Omicron being transmitted faster than the Delta variant but not resulting in severe hospitalisation or severe disease. In this scenario, there is no need for restrictions, and expectations for economic growth remain unchanged. Growth slows down to sub-2% in 2022 while inflation remains anchored at about 4.5%.
A gradual normalisation in interest rates would be appropriate.
Fourth, and the most unlikely scenario, is a complete resolution of Covid-19, which would remove all restrictions and return life to what it was before the pandemic. In this scenario, demand for services, goods and labour increases and economic growth improves.
The impact on inflation remains uncertain as goods inflation likely reduces due to the removal of supply constraints.
Having outlined four scenarios, I must emphasise it is too early to assess which will play out. Best to wait and see while planning a response to each of the scenarios, after which data is tracked to assess which scenario is playing out.
For the Bank, even in normal times, January is a difficult month in which to make policy because of political and economic risks.
The impact on inflation remains uncertain as goods inflation likely reduces due to the removal of supply constraints
The start of the year is always eventful. We have the ANC’s policy pronouncement in its January 8 statement, the state of the nation address and the national budget in February. All these have macroeconomic implications, and their effects depend on the policy statements made.
Omicron has introduced more uncertainty to the usual beginning-of-year risks. Even US Federal Reserve chair Jerome Powell said that the central bank viewed Omicron as a downside risk to US employment, economic growth and inflation.
There is potential for a delayed interest rate hike by the Fed, which will offer breathing space to emerging-market central banks, including the Reserve Bank.
We are not in a high domestic inflation crisis, the Fed’s path is relatively well choreographed, and the November MPC was almost evenly split — three to two in favour of a hike.
Taking account of the November MPC and economists’ expectations (11 vs 10 in favour of a hike), the Reserve Bank should not have hiked in November but should have waited for the March MPC to pull the trigger.
One more crucial issue to highlight is that as we approach the January MPC, there are significant uncertainties around fiscal policy, especially the potential for the extension of Covid-19 grants and public sector wage agreements.
Overall, the impact of Omicron will only be understood with a considerable time lag. In this environment of low growth, high unemployment and uncertainty, combined with what appears to be a transitory rise in inflation, it would be appropriate to be cautious and not try to run in front of the Fed.
There is always the argument that this poses the risk that the Reserve Bank is behind the curve, which is valid, but where is persistent inflation in this economy?
• Mhlanga is the chief economist at Alexander Forbes and a fellow of Economic Research Southern Africa
