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Fundamental Analysis III

Following on our article on economic indicators, it is worth noting that changes in the monetary and fiscal policies of a country can have a significant impact on the economy and capital markets.

Monetary Policy

These are the broad set of actions taken by a country’s monetary authority (usually Central Banks). Central or Reserve banks tend to control interest rates to support the economy and particularly to control inflation. Central banks also closely monitor the exchange rate. How strong or weak a currency is has implications for inflation. As such, central banks tend to pay attention to the exchange rate. A weaker currency means that your exports become more competitive abroad (they are cheaper for foreigners). It also means that imports to your country become more expensive (higher prices = higher inflation).

In some extreme cases, the Central Bank must step in the market to balance the supply and demand for its currency. In case the currency is weaker than desired, it will buy its own currency or sell its foreign reserves. There is a limit to how much they can sell, because eventually they run out of reserves. If the currency is stronger than desired, they just print money and use it to buy foreign currencies.

How Monetary Policy Works

Fiscal Policy

These are actions taken by a country’s government usually to improve unemployment rates and boost economic growth. It also covers issues to do with government revenues and expenditure management.

Fiscal policy is the means by which a government adjusts its spending levels and tax rates to influence a nation’s economy. They spend money and/or cut taxes when the economy slows. They cut back their spending and increase taxes when growth gets back to normal. Government borrowing, tax and spending plans affect growth and interest rates and thereby affect the exchange rate. It can also affect the country’s credit rating and thereby its attractiveness as an investment destination.

The following are some of the key economic Indicators to watch;

  • Gross Domestic Product

Market value of all final goods and services produced within a country in a given period.

  • Industrial Production

Industrial production is a measure of output of the industrial sector of the economy. The industrial sector includes manufacturing, mining and utilities.

  • Consumer Price Index

A measure of the average change over time in the prices paid by consumers for a basket of consumer goods and services. The annual rate of change in the CPI is usually referred to as “the inflation rate”.

  • Unemployment Rate

Possibly the most widely known labour market indicator, it measures the number of unemployed people as a percentage of the labour force.

  • Retail Sales

Purchases of finished goods and services by consumers and businesses. By measuring consumer demand for finished goods, retail sales help gauge the pulse of an economy.

  • Consumer Indices

Surveys used to measure the degree of optimism of consumers on the state of the economy.

  • Communications from Central Banks
  • Release of Earnings Reports
  • Stock Prices

Chapter 2 of the Investment 101 Handbook provides a thorough overview of various economic indicators that are key for fundamental analysis. Download a Copy of the Investor 101 Handbook below;

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