How Omicron will Affect Interest Rates

The new COVID-19 “variant of concern”, Omicron, seems to be far more transmissible but potentially less deadly (although reports on this vary) than its closely related Delta variant.  While experts are still trying to understand the impacts both from a health and broader impact perspective some preliminary conclusions can be drawn.

Firstly, due to its greater transmissibility, Omicron is now widespread across the globe and unlike prior variants (such as Beta) it appears highly adaptable to many individual country conditions meaning it is likely to replace Delta as the dominant strain worldwide.  Omicron is already the dominant strain in South Africa and is predicted to be the dominant strain in the UK before the end of the year.  Early indications are that it may become the dominant strain in Australia[1]. The fear is that even if Omicron proves less deadly than Delta, its greater transmissibility will result in more cases leading to more hospitalisations and deaths; particularly if the hospital system becomes overwhelmed with cases. 

As a simple example using UK and USA statistics and data sources[2], 14% of people who are unvaccinated and who contract COVID will be hospitalised and of these 10% will die.  Vaccination reduces these statistics by approximately 90%.  If we assume 90% of the population is vaccinated then out of 10,000 cases there will be 266 hospitalisations and 27 deaths. Assuming there are 1,000 new cases a day, then 27 new people will be admitted to hospital daily of which three will subsequently die (which is broadly what is being observed in Australia currently).

Assuming hospitalisation and death rates for Omicron are half those of Delta then hospitalisation per 10,000 infections will fall to 133 and deaths 13.  However, if Omircon is far more transmissible and case numbers are allowed to explode then instead of being 1,000 new cases a day there could be 25,000 new cases a day (as recently predicted for NSW if no control measures are taken[3]). In this case we should expect 332 new hospitalisations and 33 new deaths per day.  Adding to this if the hospital system is then overloaded at these case levels and cannot provide the care needed to newly sick patients as all the beds are full, then the death rate will rise and perhaps 30% of those who cannot get treatment will die rather than the current 10%.  This would then take the death rate from 33 to close to 100 per day.  These numbers while largely illustrative outline the problem countries in Europe are currently fearing and that Australia could face in the furture if cases are allowed to explode.

Apart from health considerations, investors will also be interested in how this scenario or the measures taken to prevent it could affect markets and particularly interest rates.

Amicus thinks it is safe to assume Australian state and federal governments are not going to intentionally allow the domestic hospital system to be overwhelmed and if this does occur it will only happen due to a policy mistake (highly possible of course but from an economic perspective it does not alter the conclusions as the response will be the sames as those measures for prevention but even more severe).  Hence, it is likely Australia will initially seek to learn from the experience overseas where Omicron is spreading rapidly and domestic cases will be closely monitored and restrictions re-imposed wherever necessary to limit the spread if case numbers begin to rise too quickly.  While NSW Premier, Dominic Perrottet, has publicly stated he is only concerned with hospitalisations and not case numbers, this stance is unlikely to hold up under stress as it is obvious greater case numbers presage greater numbers of hospitalisations.

Initial indications are that Australia while well protected from Delta may be far more susceptible to Omicron due to the population’s previous levels of low infections and lack of booster shots as per the graph below from The Economist indicates. If accurate it would suggest Australia and China will be hit much harder by Omicron that the USA, UK and other European countries that are currently suffering and are increasing restrictions in response.

The question will then become by how much do cases need to be suppressed to prevent the hospital system becoming overloaded and whether this can be achieved simply by measures that have little economic impact such as mask wearing, ones that have moderate impact such as advice to work from home or ones that have greater impact such as lockdowns of hospitality venues and other business closures.  The possible effectiveness of booster shots in reducing transmissibility is also unknown and if booster shots make an impact how quickly can they be administered so that lockdowns can be avoided.

If there are any health restrictions implemented that limit economic activity, then this is likely to lengthen the time before interest rates rise since the purpose of interest rate rises is to stop the economy from over-heating which it won’t be doing if it is being suppressed due to COVID restrictions.  If the economic effects are minimal then there will probably be no change to the current predicted path of interest rates, but if the effects are major then interest rate rises will almost certainly be deferred.

The Australian interest rate outlook will be affected not just by domestic impacts, but also the potential international ones in that if economic activity slows in Europe or the USA then this will push back interest rate rises in these economies that will have a knock-on effect domestically through the exchange rates, overseas demand for Australian exports and the levels of overseas inflation. Possibly the largest potential economic effect and the one of greatest concern is if Omicron enters China and cannot be contained.  Official cases in China are currently stable and running at an average of around 75 a day which is very small within a population of close to 1.5 billion people.  However if lockdowns need to be imposed to contain an explosion of Omicron cases and this stalls the Chinese economy this will have a multiplier effect for Australia as a major trading partner and commodity supplier.

Most of the risks outlined above appear to be skewed towards an extension of the time before interest rates rise in Australia, but an alternative narrative is restrictions imposed to combat the spread of Omicron cause further supply chain disruptions leading to price rises and greater inflation that prompts the RBA to raise interest rates faster than it would do otherwise. Amicus thinks this scenario is unlikely as the RBA has stated it is focused on “sustainable” inflation through wage rises rather than “temporary” inflation caused by supply chain disruptions.  Such a situation may even have the opposite effect in that supply chain disruptions will hinder economic activity which in turn will lead to businesses investing less and hiring fewer workers and therefore putting less pressure to pay higher wages to attract workers thus suppressing wage inflation.

Finally, with the number of COVID variants seen so far, it is clear the virus mutates and will continue to do so and any variants that make it “fitter” in a biological sense being more transmissible (and where appropriate more able to evade vaccines that would otherwise limit its transmissibility) are likely to become dominant. This will occur in the same way the Alpha variant replaced the original strain and then was itself replaced by Delta and now Delta looks as if it is being replaced by Omicron. Whether a new variant will be more deadly is unknown and biologically it could go either way as killing ones host before the host’s immune system kills you is not necessarily an unhelpful characteristic for a virus unless it is a limiting factor on transmissibility. This is because transmissibility is ultimately how the virus keeps surviving longer term by continually finding new hosts and continuing to mutate to become more effective at finding new hosts. The risk of a highly transmissible and far more lethal variant emerging remains which would obviously be a disaster both from a health and economic perspective, but equally a highly transmissible virus that was non-lethal and which gave everyone natural immunity against re-infection could be a blessing. This is broadly the state to which other coronaviruses such as the common cold have eventually evolved.

This last scenario is an “unknown known” or a “known unknown” to use Donald Rumsfeld’s classifications in that it is unknown whether there will be further dominant strains emerge beyond Omicron but if they do it is known they will need to be “fitter” in a biological sense to become dominant or equally it is known that the virus will continue to mutate, but it is unknown what effects of this will be. This level of uncertainty (or confusion) can also be applied to the economic effects and so the possibility of “wildcard” economic impacts due to possible future COVID mutations needs to be considered although to do so is very difficult.

[1] Kirby Institute as reported in the Guardian 15 December 2021

[2] BMJ – How is Vaccination affecting hospital admissions and deaths 20 September 2021 and Petersen- KFF Health Tacker COVID-19 Breakthrough hospitalisations 15 December 2021

[3] Brad Hazzard, Health Minister for NSW on 15 December 2021 as reported in SMH

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