Tue Feb 17 03:30:00 CST 2015

Consensus Actual Previous
Month over Month -0.8% -0.9% 0.0%
Year over Year 0.3% 0.3% 0.5%

Inflation took a few more steps closer to zero in January. A 0.9 percent monthly drop in the headline CPI was only fractionally steeper than expected and reduced the annual inflation rate from 0.5 percent in December to just 0.3 percent, its lowest posting since March 1960. A negative yearly rate is almost certainly just a few months away.

However, the weakness of the headline data masked a slightly firmer underlying picture and a 0.8 percent monthly drop in the core CPI was enough to see its yearly change edged a notch higher to 1.4 percent.

Inevitably tumbling energy costs were once again the dominant factor and this was particularly apparent in the transport sector where prices fell a monthly 2.0 percent versus December compared with just a 0.6 percent drop in the year ago period. Food and non-alcoholic beverages also had a negative impact; falling 0.7 percent this month versus a rise of 0.2 percent in January 2014. Alcohol and tobacco (1.4 percent versus 3.1 percent) similarly depressed the overall annual rate.

The main upward pressure on the yearly change came from clothing and footwear where prices fell a monthly 3.7 percent this January compared with a 5.4 percent decline last year and furniture and household equipment (minus 2.5 percent after minus 3.1 percent).

Today's data will come as no surprise to the BoE MPC. In his recent letter to the Chancellor explaining why inflation is below 1 percent, the bottom end of its 1-3 percent target range, BoE Governor Carney pointed to the combination of sharply weaker oil costs, a strong pound and still highly competitive product and service sector markets. The same factors will also have a major effect on overall consumer prices in coming months. This should help to keep any talk of a hike in Bank Rate this year at a minimum but, in current conditions, it is more important than ever to keep an eye on the core CPI and wage developments (note tomorrow's wages data).

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.