Wed Jan 07 04:00:00 CST 2015

Consensus Actual Previous
Year over Year -0.1% -0.2% 0.3%

Eurozone inflation in December provisionally fell below zero for the first time since October 2009. At minus 0.2 percent the yearly change in the flash HICP was down fully 0.5 percentage points from its final November print and below market expectations.

However, inevitably weakness in headline prices was dominated the collapse in oil costs and, potentially significantly, at least one underlying measure actually accelerated slightly. Hence, excluding food, alcohol, tobacco and petrol the annual rate surprisingly edged up a tick to 0.8 percent, its first increase since August. Omitting just unprocessed food and petrol the yearly change was steady at 0.7 percent.

Non-energy industrial goods prices were flat versus December 2013 after a 0.1 percent drop in November and inflation in services was steady at 1.2 percent. Rather, the other main negative impact on headline prices came from food, alcohol and tobacco where annual inflation slowed from 0.5 percent to 0.0 percent.

With the price of Brent crude sliding below $50 a barrel this morning and generally seen declining still further over at least the near-term, there will be plenty of additional downside pressure from the energy sector on headline inflation at the start of 2015. Inevitably the ECB will seek to highlight the relative stability of the core rate but ultimately its target is couched in terms of overall consumer prices and the total HICP has not been anywhere close to that mark since early 2013.

Moreover, household inflation expectations are much more likely to be impacted by the full price basket than just a selected subset. Today's figures, if hardly a major surprise in financial markets, could still prompt a further downgrading of such expectations over coming days. Indeed, one of the ECB's preferred gauges of investor price expectations, the euro 5-year/5-year inflation swap rate, extended its recent fall to a new record low this morning.

Despite the slightly firmer performance by one core measure, the unexpectedly large drop in overall HICP inflation will ensure that speculation about the ECB's near-imminent switch to QE will continue to gain ground.

The harmonized index of consumer prices (HICP) is an internationally comparable measure of inflation calculated by each member of the European Union using a specific formula. Since January 1999, the European Central Bank has used the HICP as its target measure of inflation. The early, or flash, estimate based on incomplete data is released about two weeks before the detailed release. This contains only a limited breakdown but still provides some early insights into underlying developments.

The measure of choice in the European Monetary Union (EMU) is the harmonized index of consumer prices which has been constructed to allow cross member state comparisons. An investor who understands how inflation influences the markets will benefit over those investors that do not understand the impact. In the European Monetary Union, where monetary policy decisions rest on the ECB'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 HICP are small (large). The equity market rallies with the bond market because low inflation promises low interest rates and is good for profits.