Fri Jul 31 04:00:00 CDT 2015

Consensus Actual Previous
Year over Year 0.2% 0.2% 0.2%

Eurozone HICP inflation was provisionally unchanged at a 0.2 percent annual rate in July, in line with market expectations. This was the fourth month in a row that inflation has been in positive territory but, with both June and July below May's 0.3 percent peak, the trend would seem to be at best only flat.

That said, underlying developments were rather stronger with both core measures gaining ground at the start of the quarter. Hence, excluding food, alcohol, tobacco and energy prices were up 1.0 percent on the year, a couple of ticks above their final June mark. Similarly, omitting just unprocessed food and energy the annual rate gained 0.1 percentage points to 0.9 percent.

The stability of the headline print masked a mixed performance amongst the main basket components. Thus, while yearly rates fell in energy (minus 5.6 percent from minus 5.1 percent) and food, alcohol and tobacco (0.9 percent from 1.1 percent), there were gains in both non-energy industrial goods (0.5 percent from 0.3 percent) and services (1.2 percent from 1.1 percent).

Today's inflation update might not surprise the ECB but it may provide some limited reassurance that prices are on course to meet their medium-term near-2 percent target. That said, signs of a softening in consumer confidence, a renewed fall in inflation expectations and a stubbornly sluggish economic recovery all suggest that deflation risks are still very much alive.

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.