The forex market is the most liquid and largest trading marketplace globally, running trillions of dollars of trades every day. However, to remain on top of the game, forex traders must keep track of the economic calendar to be at par with any potential volatility posed by news events and economic announcements.
The economic calendar contains information that forms some of the critical economic indicators for fundamental analysis of the forex markets. One of the primary economic indicators that forex traders monitor keenly is the industrial production index.
This indicator has a significant impact on a country’s currency value, which traders cannot afford to miss. This article introduces you to industrial production and the metric’s impact on the forex markets.
What is Industrial Production?
This is the measure of a country’s total output in the manufacturing mining and utility industries. Industrial production indexes (IPI) show the growth rate of an economy relative to the industrial sector within a stipulated timeframe.
While the Gross Domestic Product GDP measures the price paid by consumers and other sectors to purchase goods and services, IPI looks at production based on prices paid to manufacturers to release the final product.
How the Industrial Production Index Works?
The IPI is released by the responsible bodies, such as the Office for National Statistics of the UK and Federal Reserve Board of the United States, on a monthly basis. Industrial production measures production levels by the industrial market relative to a base year.
These sectors include the manufacturing sector, electricity and gas utilities, and mining (comprising of drilling services for oil and gas). The annual variation of the industrial output is calculated as a percentage, reflecting the overall change in the level of manufacturing output produced year on year.
IPI is also used to measure the capacity and capacity utilization (CU) of a country. Capacity, in this case, refers to an estimated level of production that can be maintained over time. CU, on the other hand, is a metric used to indicate the actual output to capacity ratio.
How Industrial Production is calculated?
IPI is calculated relative to a base year. The current base year is 2012. IPI and capacity levels, therefore, do not reflect the production volumes of a country in absolute values. Instead, the index expresses changes in production relative to the base year (2012).
The product data may come with variance due to multiple reasons, such as inflation adjustment of sales figures and the physical inputs and outputs of a given product. Also, the duration logged by production workers may cause this variance, especially when the data sources are unavailable in real-time.
Consequently, the publishing agency or board acquires this data from government agencies and industry associations, then aggregates them into the IPI using specified formulas, such as the Fisher Ideal formulae.
How is the Industrial Production Index Interpreted?
Whether it is a specific sector, such as steam and air conditioning or products that are actively traded globally, such as electricity gas and oil, industry-based data is vital for investors and policymakers.
The IPI, on the other hand, plays a critical role as a macroeconomic indicator for analysts and traders seeking to speculate the direction of the forex market.
When there are fluctuations in the volumes of the industrial or manufacturing sectors, the economic status of a country is impacted holistically. Monthly publications by the reporting agencies on the industrial capacity of a country enable investors to predict possible shifts in the future output of the industrial market.
How Industrial Production Affects the Forex Markets
Although the industrial market comprises of a falling share of some economies, such as the UK and the US, the movement of volumes of industrial output cannot be ignored. If the total industrial output dropped in a given timeframe, the economic health of a country is also impacted.
This is because a decline in the value of the industrial market may trigger a drop in the GDP indirectly. Such factors as increased unemployment, inflation, low business profits, and reduced wages are also triggered.
A drop in the industrial market may also see the country lose foreign investment to a certain degree, following a decline in the value of exports. All these factors have a negative impact on a country’s currency.
Also, various participants of the forex market may interpret movements in the industrial market differently. For example, policymakers and central banks may view a drop in industrial production and capacity as a potential weakening of the currency.
Investors and traders may, on the other hand, interpret this decline as a possible economic downturn in the future. This may trigger policymakers to adjust interest rates as a response to such threats. As a result, the change in a country’s rate of interest may significantly impact the value of the currency.
Generally, industrial production measures the output of the industrial market in relation to a base year. The volumes of output in this sector are subject to changes on a monthly basis, which investors use to determine the value of an economy relative to the manufacturing sector. If well tracked, IPI can be a fundamental tool in the success of a forex trader.