What it means
These indices are produced by statistics agencies, central banks, chambers of commerce and private research firms, usually monthly or quarterly. The questions are deliberately simple and rarely change, which is what allows the results to be compared over decades.
The underlying maths is a diffusion index rather than an average. Answers are reduced to a net balance, the share of firms expecting improvement minus the share expecting deterioration, and that balance is then rebased so that a reading of 100 means optimists and pessimists cancel out.
It matters because confidence drives behaviour before it shows up in the hard data. A finance director who expects a weak year defers a hiring round and trims capital spending now, and if enough directors do the same the expectation becomes partly self-fulfilling.
Users watch the direction and the rate of change more closely than the level. A move from 96 to 104 tells you something has turned, while a steady 104 for four quarters is closer to background noise.
The obvious limitation is that sentiment can simply be wrong. Managers are influenced by headlines and by their own recent trading, so confidence indices sometimes overreact to events that never affect actual orders.
In practice
Real-world examples.
Example
A staffing agency watches the quarterly confidence index for its main sectors and sees the reading fall from 108 to 94. It slows its own recruitment of consultants a full quarter before vacancy volumes actually drop.
Example
A bank uses a business confidence series alongside loan application data to set provisioning for the year ahead. Falling confidence among small firms prompts a tightening of credit criteria before default rates have moved at all.
Example
A packaging manufacturer notices that confidence among food producers, its main customers, has risen for three consecutive quarters. It brings forward a decision on a second production line, judging that order growth is likely to follow.
Think of it
“Business confidence shows how optimistic companies feel-an investment indicator.
Formula
Calculation
Net balance = % of respondents expecting improvement - % expecting deterioration
Index = 100 + net balance
A quarterly survey of 1,200 firms finds that 42% expect trading conditions to improve, 40% expect no change and 18% expect conditions to worsen. The net balance is 42 - 18 = +24, so the index reads 100 + 24 = 124.
In the previous quarter the same survey found 30% expecting improvement, 38% expecting no change and 32% expecting deterioration, a net balance of 30 - 32 = -2 and an index of 100 - 2 = 98. The move is 124 - 98 = 26 points, a sharp swing from mild pessimism to clear optimism.
The index says nothing about how strongly firms feel. In the current quarter 42% of 1,200 respondents is 504 companies expecting improvement, and each one counts the same whether it expects orders to rise by 1% or by 20%.Case study
Seen in the real world.
The following is a fictional, illustrative story. Halden Machine Tools, an invented supplier of factory equipment, sold products with a nine month manufacturing lead time and had been repeatedly caught out by demand turning before its order book did. Its planning had always started from the current order book alone.
In the illustrative change, the planning team began plotting the manufacturing sector confidence index against its own order intake and found that intake tended to follow the index by roughly two quarters. They built a simple rule: two consecutive quarterly falls of more than five points triggered a review of component commitments.
When the index dropped from 106 to 99 and then to 92, Halden cut its steel and casting orders and moved two production shifts to maintenance work. The fictional result was that when demand fell about six months later, the company carried far less unsold work in progress than the competitors who had waited for their order books to tell them.
Watch out
Common mistakes.
- Reading the index as a measure of what has already happened, when it records expectations about what respondents think will happen next.
- Comparing indices from different providers as though they were the same series, when sample, questions and scaling all differ.
- Reacting to a single reading, since sentiment surveys are volatile and only a run of movements in one direction is meaningful.
Questions
People also ask.
Does a reading above 100 mean the economy is growing?
Not necessarily; it means more surveyed firms expect improvement than deterioration, which is a signal about direction rather than a measure of output.
How is a business confidence index different from a consumer confidence index?
One surveys company managers about trading conditions and the other surveys households about their finances and spending intentions, and the two can move in opposite directions.
Can a small business use these figures?
Yes, particularly sector or regional breakdowns, which can inform hiring, stock and capital spending decisions several months before the effect reaches the order book.
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