Tue Jan 05 04:00:00 CST 2016

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

Eurozone inflation was slightly softer than expected in December. At 0.2 percent, the flash annual rate was unchanged from its final November reading and, although comfortably above the January 2015 low (minus 0.6 percent) still dangerously close to the psychologically important zero mark.

The stable headline print masked essentially offsetting volatility in the more erratic components. Hence, a rise in the annual inflation rate in energy from minus 7.3 percent to minus 5.9 percent contrasted with a drop in food, alcohol and tobacco from 1.5 percent to 1.2 percent. Non-energy industrial goods saw no change at 0.5 percent while overall services dipped a tick to 1.1 percent. Excluding food, alcohol, tobacco and energy inflation was flat at 0.9 percent and omitting just unprocessed food and energy it was 0.1 percentage points lower at 0.8 percent.

Accordingly there is little here for the ECB to be happy about. Underlying trends look to be moving broadly sideways but at rates too low to offer any real hope that policy is doing enough. At the same time headline inflation remains hopelessly adrift from its near-2 percent medium term target. The ECB is in wait-and-see mode for the time being but risks to policy stability in 2016 are still stacked in favour of additional easing.

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.