What is Economic Growth and Why is it So Important?
Top news headlines are often dominated by the release of gross domestic product (GDP) figures and for good reason. The GDP release attracts a lot of attention from traders and market participants because of its signaling effect and ability to move financial markets.
This article explores the concept of ‘growth’ from an economic perspective and why it is beneficial for traders to have a solid understanding of the subject.
What is GDP Growth and How is it Reported?
When news outlets or financial publications refer to ‘growth’ they generally mean gross domestic product or GDP.
GDP measures the value of goods and services produced by a country in a given year and serves as an indication of economic health of that country. Essentially, it’s an objective measure of improving or worsening economic conditions in a particular country over time.
How is GDP Reported?
GDP has four main readings, one per quarter, often denoted as Q1, Q2, Q3 and Q4; but you may notice that GDP figures are reported every month. This is because GDP is a lagging economic indicator, meaning that there is a lag period before the data is collected, analyzed and adjusted to account for seasonal influences. Lagging economic indicators are not to be confused with lagging technical indicators.
GDP figures are mainly reported as a quarter on quarter figure (QoQ) or year on year (YoY). The below image shows the percentage change in real GDP* (QoQ):
*Real GDP provides a more accurate indication of production/output as it removes the influence of higher prices on the value of aggregated goods and services in the economy
There are three reported figures for each quarter:
- The preliminary/advance figure
- The second estimate and
- The final GDP figure.
The preliminary/advance figure tends to have the biggest impact from a trading point of view as the other two figures generally involve small refinements to the initial figure. The component factors that make up GDP can often be observed and aggregated ahead of the released figure, meaning GDP is less likely to provide a shock to the market than other data releases such as Non-farm Payrolls (NFP).
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However, do keep in mind that for major economies an estimated GDP growth figure that differs from the actual by 0.3 or 0.2 percentage points can translate into billions of dollars -which may attract varying opinions of the state of the economy and result in elevated volatility after the release.
For more information on these releases, click the drop down arrow next to the event on the DailyFX economic calendar
GDP Growth and the Signaling Effect
The state of the economy is watched very closely by governments and central banks. When the economic growth (GDP) is stagnant or the economy is technically in a recession, central bank policy shifts and becomes more ‘accommodative,’ providing liquidity and lowering interest rates; while increased government spending often follows suit. In economic booms central bankers look to reign in overheating economies and monetary policy becomes more ‘contractionary’ in nature – raising interest rates, while governments often reduce spending.
Longer-term macro traders are able to analyze whether an economy is in a boom, recession or transitionary phase when planning trade set ups. Currencies linked to central banks that are ‘hawkish’ tend to appreciate at the start of an interest rate hiking cycle; while currencies linked to central banks that are ‘