Understanding how economic indicators can assist with predicting future performance of an economy
An economic indicator is a statistic about economic activity. Economic indicators help paint a picture of how an economy is performing and assist with predictions of future performance. Examples of key economic indicators are gross domestic product (or GDP) which is a measure of the size of an economy, unemployment, changes in the consumer price index (which is a measure for inflation), industrial production and retail sales. Economic indicators are also important in that they can influence interest rates, exchange rates, commodity and stock market prices.
For many economic indicators, analysts are more concerned about the change in the number rather than the actual number itself. For example, GDP in Australia in the three months ended 30 June was A$471 billion, but this figure was 5.5% higher than the same period in 2017, indicating that the economy has grown 5.5% in nominal terms over the past year. Some economic indicators are published monthly and therefore we compare month-on-month (mom) changes (e.g. retail sales was flat over the prior month) but for other indicators, which are quarterly, we compare quarter-on-quarter (qoq) or year-on-year (yoy) changes to see how much this indicator moved over the past three months or past year, respectively.
Some economic indicators may also be reported on a seasonally-adjusted or trend basis. These are statistical methods of correcting or smoothing data. For example, “seasonally-adjusted” means the impact of seasonal cycles in certain indicators, such as the retail sales pick up in December / January is adjusted for so meaningful comparisons with prior months can be made. Other indicators may be very volatile from month to month, such as building permits for apartments, so monthly changes may not be that useful – therefore economists tend to discuss the trend or moving average numbers, which attempt to strip out the monthly “noise” from the indicator.
Economic indicators can be broken into three categories based on their timing relative to the business cycle. Leading indicators tend to move before the economy changes – for example building permits are needed months before actual construction activity picks up, purchasing managers’ indices (PMIs) or surveys of manufacturers take into account new orders which precede actual increases in manufacturing activity and business and consumer sentiment surveys ask about future spending, investment and hiring intentions. Lagging indicators usually change after the economy as a whole has changed. Examples include unemployment, consumer prices, house prices, corporate profits and official interest rates which all tend to move after changes in economic activity. Coincident indicators change at approximately the same time as the entire economy and tell us about the current state of the economy such as GDP, industrial production and retail sales.
At present, investors are particularly focussed on US and European inflation and US unemployment which can signal the direction of interest rates in the United States and Europe. Also important for Australian investors is GDP growth and PMI readings in China which are important for our mining industry as they can provide signals about future demand for our raw materials, which can in-turn impact share prices and exchange rates. Other indicators which are relevant in Australian is core inflation (which strips out the impact of volatile items such as fuel prices), business surveys, retail sales and unemployment which are all used by the Reserve Bank Board as part of its decision-making process as to whether to change official interest rates.
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