Tue Jan 13 03:30:00 CST 2015

Consensus Actual Previous
Month over Month 0.1% 0.0% -0.3%
Year over Year 0.6% 0.5% 1.0%

Consumer prices were slightly softer than expected in December. An unchanged level versus November was weak enough to shave fully 0.5 percentage points off the annual inflation rate which now stands at just 0.5 percent, equalling its lowest mark since the series was first published in 1989.

The main negative effects on the annual headline rate came from the housing and household services sector. Here, prices were unchanged on the month this year versus a rise of 2.3 percent between the same two months in 2013. Instrumental were gas and electricity charges which were essentially flat this time round following an increase a year ago. The other sizeable downward impact stemmed from lower transport costs which were off 0.2 percent on the month this December compared with a 1.0 percent increase over the same period in 2013. Almost all of this was attributable to the fall in the price of petrol and diesel. The only upward contribution of note came from alcohol and tobacco where this December's 0.2 percent monthly drop was well short of the 1.2 percent decline a year ago.

In fact, underlying prices actually accelerated slightly with a 0.2 percent monthly increase in the core CPI nudging its annual rate a tick firmer to 1.3 percent. As such, the headline figures are somewhat misleadingly soft but the bottom line is all the main measures of inflation are comfortably below the CPI's 2.0 percent medium-term target. In this environment the BoE's doves should remain the dominant force on the MPC.

Of interest, but little direct market significance, today's data mean that Mark Carney will acquire the dubious distinction of becoming the first BoE Governor to write a letter to Chancellor Osborne explaining why inflation is more than 1 percentage point below target. However, changes to the conventions surrounding the letter mean that it will not be made publicly available until the February MPC meeting minutes are released (18th February). Carney's predecessor, Mervyn King, had to write some fourteen such letters explaining why inflation was more than 1 percentage above 2 percent.

The consumer price index is defined as an average measure of the level of the prices of goods and services bought for the purpose of consumption by the vast majority of households in the UK. It is calculated using HICP methodology developed by Eurostat, the European Union's statistical agency. The CPI is the Bank of England's inflation measure.

The consumer price index is the most widely followed indicator of inflation. An investor who understands how inflation influences the markets will benefit over those investors that do not understand the impact. In countries such as the UK, where monetary policy decisions rest on the central bank's inflation target, the rate of inflation directly affects all interest rates charged to business and the consumer.

Inflation is an increase in the overall prices of goods and services. The relationship between inflation and interest rates is the key to understanding how indicators such as the CPI influence the markets - and your investments.

Inflation (along with various risks) basically explains how interest rates are set on everything from your mortgage and auto loans to Treasury bills, notes and bonds. As the rate of inflation changes and as expectations on inflation change, the markets adjust interest rates. The effect ripples across stocks, bonds, commodities, and your portfolio, often in a dramatic fashion.

By tracking inflation, whether high or low, rising or falling, investors can anticipate how different types of investments will perform. Over the long run, the bond market will rally (fall) when increases in the CPI are small (large). The equity market rallies with the bond market because low inflation promises low interest rates and is good for profits.

For monetary policy, the Bank of England generally follows the annual change in the consumer price index which is calculated using the European Union's Eurostat methodology so that inflation can be compared across EU member states.