A country’s Gross Domestic Product represents the total value of all goods and services produced with in the country for a given period of time. It involves consumption, government expenditures, investments and net exports/trade balances (exports-imports).
The Gross domesitic product can be calculated by the formula
C + I + G +( X-M)
C – Consumption
I – Investment
G – Government expenditure
(X-M) -(Exports -Imports)
GDP is one of the major economic indicators that measure the state/health of country’s economy. GDP is calculated by comparing the last quarters or years figures with the current figures eg if the country’s GDP is up to 2% this means that it has performed to 2% over the last year.
The country’s GDP can be measured in two different ways;
The nominal GDP and the Real GDP.
1. Nominal GDP
This measures the value of all goods and services at current market price. it includes all the changes in the price that have occurred during the year due to inflation or deflation.
The nominal GDP can be calculated by using the three approaches, that is:
The expenditure approach: This involves summing up the market value of all domestic expenditures incurred on all final goods and services within a single year. These expenditures include consumption expenditures, investment expenditures, government expenditures, and net exports.
The production approach: This is done by subtracting the intermediate consumption such as cost of materials, supplies and services used in production of final output from the total estimated output.
The income approach: Here nominal GDP is determined by taking the sum of all income such as wages, profits, rents, and interest income earned buy firms and households in a single year.
2. Real GDP: This is the GDP expressed in the base year prices. Real GDP accounts for changes in the level of prices caused by inflation or deflation.
The country’s GDP assesses the over all state of the economy and this reflects the currency performance in the forex market. It can be released monthly or quarterly in a year.
GDP is calculated annually but some country’s provide GDP estimates monthly or quarterly and the final GDP at the end of the year. It can be used for comparison purposes by looking at the current and previous quarter to gauge the current performance of the country and also compare productivity of different countries.
The GDP data is published and released by the Bureau of Economic Analysis (BEA) either monthly quarterly or yearly.
How GDP indicator affects the forex market.
GDP indicator measures the growth and contraction of an economy.
When the GDP rate rises, it indicates high economic growth which is likely to be associated with inflation. This is likely to be followed by interest rate hike to curb down high prices. High economic growth and interest rates make the currency expensive in value and the forex market become more bullish as most investors buy more of that currency.
On the other hand, when the GDP rate falls, its an indication for a collapsing economy, this may call for the central banks to cut interest rates to encourage domestic expenditure and boost economic development. As a result the domestic currency loses value and the forex market becomes more bearish due to most investors selling off the currency to buy a higher yielding currency.
At the release of such data, the markets go volatile due to a lot of speculators waiting up on the news release. A higher GDP than expected shows that the countries economy is doing great compared to the last years which gives a positive signal for a healthy economy hence more traders will invest in that currency. It is also an indicator that interest rates could also increase soon which will soon lead to the rise of the value of that currency in the fx market.
However, if the GDP figure is less than expected, it shows that the economy is not doing good weakening the domestic currency and traders are likely to sell off the currency .
Investors and traders compare the countries previous GDP with the current and base on the difference for their future predictions.
If the GDP is positive or exceeds the previous years GDP, the currency strengthens . If it is negative or below the previous years, the currency weakens.
Therefore, looking at GDP rate, you will be able to pair up a strong currency with a weak currency to get a strong trend.
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