Fundamental analysis based on economic indicators is a very significant element in development of forex trading strategies. Most brokers out there tend to provide their customers with some sort of information regarding economic indices either through their trading platform or on their websites, free of charge. One of the most important economic indices is the ECI – Employment Cost Index.
What exactly does the Employment Cost Index measure?
In general wording, the Employment Cost Index measures the costs of conducting business in a certain country. It calculates variable data such as changes in average salaries of hired workers, additional bonuses and privileged prices/taxes for them. In fact, the Employment Cost Index is important enough to influence some monetary decisions by the Federal Reserve.
Relationship to Inflation
The relationship between inflation and monthly changes in average salaries is very important when reviewing the ration between price growth and salary growth (along with buying power). For example, if the current level of inflation is at 3% yearly, but salaries are growing at 2%, even despite the general positive tendency in salary growth, the buying power of the same average salary is diminishing when put against necessary everyday expenditures of a regular citizen. This has a negative influence on the country’s economy (a decrease of citizen expenditures results in less profit for domestic and international companies, which in turn pay less taxes), and in the long term, its currency exchange rate. On the other hand, if salaries show a growth of 3% (along with all social security benefits and bonuses), while inflation remains at 2% yearly level, this will most definitely result in the growth of the national economy and currency exchange rate.
This index does show a tendency to lag, but it is still very important!
Even though the Employment Cost Index is a lagging indicator, it is still a very important factor to be considered, and many trading strategies revolve around it. ECI, when growing or declining, gives a solid picture of the economic environment, and can help for long- and mid-term strategic planning. For example, let’s say that a certain economy is showing signs of weakening over the course of several months, but news and technical analysis only provides controversial information. The Employment Cost Index is published, and it shows a decrease in salaries, with all of the consequent pain for the economy and its currency. Having such information can be the tipping point in many a situation, and is great to keep track of for any long term, swing trade.