Fri Jan 23 07:30:00 CST 2015

Consensus Actual Previous
CPI-M/M -0.5% -0.7% -0.4%
CPI-Y/Y 1.7% 1.5% 2.0%
BoC Core-M/M -0.4% -0.3% -0.2%
BoC Core-Y/Y 2.1% 2.2% 2.1%
Core CPI-M/M -0.4% -0.3%
Core CPI -Y/Y 1.9% 2.0%

Tumbling energy costs saw consumer prices fall a sharper than expected 0.7 percent on the month in December. This reduced the headline annual inflation rate from 2.0 percent in November to 1.5 percent, its lowest mark since March 2014.

However, after omitting the negative effects of lower oil prices, the underlying picture was predictably more robust. Hence, a 0.4 percent monthly decline in the ex-food and energy index reduced its yearly rise by just a tick to 1.9 percent while a 0.3 percent decrease in the BoC's index saw its annual rate actually edge up from 2.1 percent to 2.2 percent, a tick higher than anticipated.

Seasonal factors are also quite strongly negative at year-end and adjusted for these the CPI was down only 0.1 percent versus mid-quarter after a 0.2 percent dip in November. On the same basis, both the ex-food and energy measure and BoC's gauge rose 0.2 percent. The continued weakness of gasoline prices was particularly evident again in transportation which, with a further 1.2 percent decrease, had easily the largest negative impact on overall prices. Elsewhere, clothing and footwear dropped 0.3 percent while health and personal care and alcoholic beverages and tobacco products were off 0.2 percent. Food registered a 0.5 percent gain and shelter was 0.2 percent more expensive.

Coming just after the BoC's surprise 25 basis point cut on Wednesday the December inflation update should have little impact on financial markets. The central bank is now expecting annual headline inflation to drop to 0.5 percent this quarter and its measure of the underlying rate to ease to 2.0 percent.

The Consumer Price Index is a measure of the average price level of a fixed basket of goods and services purchased by consumers. Monthly changes in the CPI represent the rate of inflation. Changes in the CPI are critical to the Bank of Canada which has an inflation target range of 1 percent to 3 percent.

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 Canada, 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.

As the most important indicator of inflation the CPI is closely followed by the Bank of Canada. The Bank of Canada has an inflation target range of 1 percent to 3 percent but focuses on the 2 percent midpoint. It uses CPI and core which excludes food and energy as their prime inflation indicators. However, for operational purposes, the Bank also monitors a core CPI which excludes eight volatile items including fruit, vegetables, gasoline, fuel oil, natural gas, mortgage interest, inter-city transportation and tobacco products.