By Marc Jones
LONDON (Reuters) - The newly-discovered Omicron variant shows policymakers and financial markets cannot lower their guard on COVID-19 and will have to calibrate their policies carefully, the Bank for International Settlements said on Monday.
Dubbed the central bank to the world's central banks due to its regular gatherings of decision makers, the Swiss-based BIS said Omicron had already caused falls in major stock markets and ramped up uncertainty.
"The emergence of Omicron indicates that we should not lower our guard," Claudio Borio, head of the BIS' Monetary & Economic Department told reporters. "This was the latest reminder that we have to be watchful."
As uncertainty rises over the potential human and economic costs of the new variant, global financial markets are also waiting to see whether surging inflation drives major central banks like the U.S. Federal Reserve, Bank of England and European Central Bank to raise interest rates.
Financial conditions have already been tightening for many emerging market economies, the BIS report said. Government bond yields - a proxy for the cost of borrowing - have risen, especially outside emerging Asia, while a broad-based weakening of EM currencies has compounded inflationary pressures.
Omicron could exacerbate supply-chain bottlenecks in the short run and some impact on economic activity was inevitable, particularly in the first quarter of 2022, Borio said.
"This of course makes the trade-offs the central banks are facing slightly more complicated than they were before," he added, although dealing with such complications was something policymakers were now well used to.
As usual, the BIS report also contained analyses on specific market issues.
In one, the Swiss-based forum said bank-like rules were needed to stop investment funds from destabilising finance in market crises. [L8N2SM45C]
It warned policymakers risked falling behind the curve in regulating entities such as hedge funds, pension funds, insurance companies and money market funds which collectively account for half of global financial activity.
Asia's emerging economies should improve oversight of foreign exchange liquidity risks, too, and make currency hedging more flexible as growing dollar investments make the region more vulnerable to currency swings.
It also flagged though how China's yuan currency had stayed stable despite the headwinds now facing emerging markets and the specific "challenge" the BIS said, of the property sector where developers such as China Evergrande have run into trouble.
(Additional reporting by Huw Jones in London and Daniel Leussink in Tokyo; Editing by Catherine Evans)