Foundations · F6 · 8 min
Growth and the business cycle
Read GDP and business surveys, convert between US and UK growth figures, and measure how surprising a release was.
In the news: GDP figures and business surveys tell markets whether the economy is growing or shrinking.
The essentials
- GDP
- is the value of everything an economy produces, usually counted by who spends: households, business investment, government, and exports minus imports. Households are more than half of UK and US GDP.
- Real and nominal growth
- Nominal growth includes price rises; real growth strips them out. Headline GDP growth is real: spending up 6% with prices up 4% is about 2% real growth.
- Contribution to growth
- A part’s effect on headline growth depends on its size as well as its pace: household spending at 60% of GDP rising 2% adds 1.2 percentage points.
- Quarterly and annualised
- The UK reports growth against the previous quarter; the US annualises it, as if it ran for a whole year. A UK 0.5% quarter is about 2.0% in US terms.
- Recession
- A broad fall in activity. The UK rule of thumb is two quarters in a row of falling real GDP; in the US a panel of economists makes the call.
- PMI
- A monthly survey of firms: the share reporting higher activity plus half the share reporting no change. Above 50 means growth, below 50 contraction. It measures how widespread growth is; it says nothing about its size.
Contribution to growth and annualising
contribution = share × growth; annualised = (1 + q)⁴ − 1
- share
- the component’s share of GDP
- growth
- the component’s own growth over the period
- q
- quarter-on-quarter growth (0.5% = 0.005)
How it works
1. Everything the economy makes
Add up the value of everything a country produces in a year and you have its , or GDP. If it is bigger than last year, the economy has grown: from £2,000bn to £2,040bn is 2% growth.
2. Who is spending
GDP is usually counted by who spends: households (C), business investment (I), government (G), and exports minus imports (X − M). So GDP = C + I + G + (X − M). In the UK and the US, household spending is more than half the total.
3. Each part’s contribution
A part’s effect on growth is its share of GDP times its own growth. If household spending is 60% of GDP and rises 2%, it adds 0.6 × 2 = 1.2 percentage points. A small part growing fast can matter less than a big part growing slowly.
4. Real and nominal
If spending rises 5% but prices rose 3%, the economy produced only about 2% more. Growth after stripping out price rises is real growth; growth before it is nominal. Headlines about GDP growth mean real growth.
5. Booms and recessions
Economies grow in waves: spells of expansion, then slowdowns. A is a broad fall in activity. In the UK the usual rule of thumb is two quarters in a row of falling real GDP; in the US, a panel of economists makes the call.
6. Quarterly and annualised
The UK reports growth for the quarter: 0.5% means 0.5% more than the previous quarter. The US reports the same thing annualised, as if it carried on for a whole year: 1.005⁴ − 1 ≈ 2.0%. So a US 2% quarter is about a UK 0.5%.
7. Surveys come first
GDP arrives weeks after the quarter ends, so markets watch monthly surveys of firms: the , or PMIs. Each firm says whether activity is higher, the same or lower. The index is the % saying higher plus half the % saying the same, so 50 means no change.
8. Reading a PMI
Above 50, more firms are growing than shrinking; below 50, the reverse. The change from last month shows momentum: 52 after 54 is still growth, but slower. A PMI tells you how widespread growth is, not how big it is.
9. Markets trade the surprise
Before each release, economists’ forecasts are averaged into a , and prices already reflect it. Markets react to the gap between the figure and consensus. Dividing that gap by the usual size of surprises makes releases comparable: 0.2 above, when misses are usually about 0.1, is a surprise of two standard deviations.
Worked example
In a quarter, UK household spending, 62% of GDP, rises 0.4%; investment, 17%, falls 1.0%; government spending, 21%, rises 0.6%; trade adds nothing. Consensus expected growth of 0.3%. (Illustrative shares.)
- Households: 0.62 × 0.4 = +0.248 points.
- Investment: 0.17 × −1.0 = −0.170 points.
- Government: 0.21 × 0.6 = +0.126 points.
- Growth = 0.248 − 0.170 + 0.126 = 0.204%: about 0.2%, 0.1 below consensus.
- US-style: 1.00204⁴ − 1 ≈ 0.8% annualised.
About 0.2% on the quarter, or 0.8% annualised: a small miss, led by weak investment.
Check yourself
9 quick questions on the explanation above.
Practice
New numbers every set. Misses and guesses go into your review deck.
In the interview
Answer out loud in under a minute, then compare.
Which single UK data release would you watch, and why?
Why might a strong jobs number be bad for equities?
Why can GDP grow while GDP per head falls, and why does that matter?
Remember
Contribution = share × growth
Markets trade the surprise against consensus, so know each release’s units, its usual surprise and which part the central bank watches.