Despite being ravaged by the coronavirus pandemic and the increased trade deficits caused by Brexit, the UK economy remains the fifth largest in the world by the measure of GDP.
In fact, it closed 2021 with an estimated GDP of $2.83 trillion, having once again moved ahead of France and recorded annual growth of 7.5% overall.
Of course, these headline numbers do little to break down the true nature and complexity of the national economy, which comprises numerous factors that contribute towards ongoing growth and performance.
We’ll explore these factors in more detail in the article below, while asking why they’re so important from the perspective of investors.
The Macroeconomy and its Key Factors
When studying the economy in any kind of detail, there are two key focuses. The most significant of these is macroeconomics, which addresses the bigger picture of an economy’s performance and contains a number of influential factors.
Macroeconomics initially addresses how an economy is functioning as a whole, before delving into the relationships that exist between different factors and how they impact the aggregate performance.
But what are the key factors and areas of studies involved in macroeconomics? Here’s a breakdown:
- Inflation: We’ve already touched on inflation, which recently peaked at a 25-year high of 6.2% in the UK. Inflation often rises amid increased public borrowing, while it describes an increase in the average cost of goods and services within a specified period of time. The quicker the pace of inflation, the higher the levels of economic instability, while steady growth (capped at around 2%) is a normal function of a national economy.
- Gross Domestic Product (GDP): We’ve already spoken about GDP, which is a broad valuation of the goods and services produced by a particular country. GDP is typically calculated on a per annum basis, while nominal figures are provided by the International Monetary Fund (IMF) ahead of each new year. In some cases, it may also be used as a measure of spending by a government, with the debt-to-GDP ratio offering an insight into the relevant rates of borrowing compared to income.
- Employment (or Unemployment): Countries regularly outline their total unemployment figures through recurring data releases, offering a clear indication of their economic wellbeing and the functionality of their labour market. Clearly, a lower rate of unemployment hints at a strong and fully functional economy where the majority of citizens are employed, although further insight can be provided by measuring this against monthly job creation statistics.
- The Economic Growth Rate: The economic growth rate is a much broader and less tangible factor, which describes the percentage shift in the cost of producing goods or services within a predetermined time-frame. This is then compared and contrasted with previous figures to reveal annual changes and long-term trends, creating valuable insights over time. Of course, the growth rate can be positive or negative, providing an immediate snapshot of an economy’s health.
- International Trade: Last, but not least, we come to international trade, which directly impacts a nation’s economic health and its annual capital inflows. International trade figures are particularly telling as they help to reveal the demand for a country’s products and services across the globe. Countries can have a trade surplus or deficit with their neighbours (either historically or in real-time), with the former scenario indicative of higher exports (sales) and a more valuable domestic currency.
The Importance of These Factors to Investors
As we can see, these individual factors each contribute heavily to the growth or decline of a national economy, while they’re often closely related to one another. There’s a strong and often inverse correlation between interest rates and inflation, for example, while international trade is also impacted directly by the base rate.
It’s also interesting to note that macroeconomic variables are categorised as being either positive, negative or neutral, depending on their precise impact on national and regional economies.
Understanding these categories also provides greater insight for investors, especially when looking to analyse historical and real-time trends to pre-empt future outcomes and growth cycles. Here’s an insight into each classification:
With positive macroeconomic variables, you’ll see a range of factors that stimulate economic growth and promote stability.
For example, increased demand for national produce can create a trade surplus and a higher value currency, while simultaneously increasing cash flows from overseas.
Reduced inflation also translates into increased spending power for households and businesses, creating a ripple effect that subsequently benefits businesses and the national economy in equal measure.
At this stage, you’ll notice that pretty much all macroeconomic factors have the potential to be positive or negative, due to their variable nature and interaction with one another.
Negative macroeconomic factors tend to have an adverse effect on growth, while they often describe unforeseen trends that are beyond the control of central governments. For example, high or increasing unemployment may occur in response to a recession, creating reduced consumer confidence and lower rates of spending over time.
In some cases, negative factors may ensue as a result of a monetary policy decision (due largely to the relationship that exists between individual components).
This could be observed during the coronavirus pandemic, where central banks slashed their base rates of interest to help curb the cost of extensive public borrowing and inadvertently triggered the huge hike in inflation that we’ve seen since.
Occasionally, circumstances combine to create neutral macroeconomic factors, which may have a broad range of potential economic outcomes.
For example, the imposition of a trade embargo (usually as a result of geopolitical conflict) is initially described as a neutral factor, primarily because the extent of the repercussions are unknown and it has yet to be seen how any future negotiations will play out.
Neutral factors can be particularly challenging for investors, who often have to observe the markets closely before making any informed trading decisions.
The Last Word for Investors
Ultimately, understanding the broad range of macroeconomic factors that shape the UK economy is crucial from an investor’s perspective, as is your ability to comprehend the relationship that exists between each one.
This is why traders of all descriptions tend to rely heavily on tools such as economic calendars, which list a comprehensive set of government and monetary policy data releases from across the globe.
Such calendars can also be tailored to deliver information that’s relevant to your particular portfolio and investment strategy, as you look to time specific trades to capitalise on expected announcements and data releases.
Using an economic calendar is only effective if you have a solid foundation of knowledge, however, which creates understanding and a sense of determinism that can stand you in good stead.
The Things That Contribute Towards the UK Economy is a feature post