Fri Jan 30 04:00:00 CST 2015

Consensus Actual Previous
Year over Year -0.5% -0.6% -0.2%

Eurozone inflation provisionally slid further into negative territory this month. At minus 0.6 percent, the annual fall in the flash HICP was 0.4 percentage points steeper than in December, slightly sharper than expected and also matched its all-time low.

Energy prices continued their slump with a yearly decline of fully 8.9 percent following a 6.3 percent nosedive last time. Food, alcohol and tobacco inflation (minus 0.1 percent after 0.0 percent) also had a small negative impact on the monthly change in the headline rate. However, more significantly, underlying developments were also worryingly soft. Hence, excluding food, alcohol, tobacco and energy the yearly rate was only 0.6 percent, a tick below the December print and the weakest on record. Excluding just unprocessed food and energy the decline was a larger 0.2 percentage points to 0.5 percent.

Elsewhere non-energy industrial goods prices were down 0.1 percent on the year after a 0.0 percent reading in December and service sector inflation was 1.0 percent or 0.2 percentage points short of its year-end mark.

The core element may not be as weak as the overall consumer price basket but its trend is down and the ECB will anyway struggle to peg private sector inflation expectations to this narrower measure. Consequently, with a negative headline inflation rate likely to be around for some time, the central bank faces a seriously daunting challenge if it is to get anywhere close to achieving its medium-term price stability goals.

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.