October 27, 2016 06:30 CDT

Consensus Actual Previous
CPI-Y/Y -0.5% -0.5% -0.5%
Ex Food-Y/Y -0.5% -0.5% -0.5%
CPI-M/M 0.2% 0.0%
Ex Food-M/M 0.0% 0.0%
Ex Food & Energy-M/M 0.0% 0.1%
Ex Food & Energy-Y/Y 0.0% 0.2%

Japan CPI data for September show that both headline and underlying measures of consumer inflation remain weak and well below the Bank of Japan's target level of 2.0 percent. This ongoing weakness in price pressures may prompt officials to push back again their forecast of when they expect to hit this target and may also strengthen the case for more aggressive monetary stimulus.

The headline CPI rose 0.2 percent on the month in September, with the annual headline inflation rate remaining steady at minus 0.5 percent, its seventh consecutive month in negative territory. Lower energy prices were again the main factor weighing on headline inflation, with the "fuel, light and water charges" category of spending showing prices fell in year-on-year terms by 6.2 percent in September after dropping by 7.2 percent in August. The "transportation and communication" category of spending also recorded negative inflation in September. This was partly offset by positive inflation in six of the ten major categories.

The impact of energy prices was also again evident in the core inflation measure, which excludes fresh food prices. This measure was also in negative territory for the seventh consecutive month in September at minus 0.5 percent, unchanged from its level in August. An alternative measure of underlying inflation, which excludes all food and energy prices, fell from 0.2 percent in August to 0.0 percent in September.

At its last policy meeting, the Bank of Japan undertook to keep expanding the monetary base until it exceeds the 2.0 percent target and "stays above the target in a stable manner". Today's data, however, show that price pressures remain very subdued, even when the impact of lower global oil prices and food prices are excluded

This suggests that there is a strong chance that officials will some time soon revise their forecasts for when they expect inflation to meet the target. Earlier this year, officials estimated that this will happen during the fiscal year ending in March 2018, but last week BoJ Governor Haruhiko Kuroda conceded that the timing for achieving the target may need to be adjusted. This may be announced as soon as the BoJ's next policy meeting to be concluded next Tuesday.

It remains unclear, however, whether the BoJ will necessarily accelerate monetary stimulus. Officials left policy settings unchanged at the previous meeting despite announcing their intention to maintain asset purchases until inflation overshoots the target. The fall in the underlying measure of inflation that strips out both food and energy prices may, however, add to the pressure on the BoJ to do more to shift inflation expectations.

The Consumer Price Index (CPI) is a measure of the average price level of a fixed basket of goods and services purchased by consumers. Annual changes in the CPI represent the rate of inflation.

The CPI has been in the spotlight as Japan struggled to make its way out of deflation. The report tracks changes in the price of a basket of goods and services that a typical Japanese household might purchase. The preferred measure is the year over year percent change. Markets will typically pay more attention to the core measure that excludes only fresh food because volatile food prices can distort overall CPI. A second core measure that excludes energy as well is also available. As the most important inflation indicator, the CPI data are closely monitored by the Bank of Japan. Rising consumer prices may prompt the BoJ to raise interest rates in order to manage inflation and slow economic growth. Higher interest rates make holding the yen more attractive to foreign investors, and this higher level of demand will place upward pressure on the value of the yen.

An investor who understands how inflation influences the markets will benefit over those investors that do not understand the impact. 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 government securities. 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.