December 26, 2016 05:30 CST

Consensus Actual Previous
Ex Food-Y/Y -0.3% -0.4% -0.4%
CPI-M/M 0.0% 0.6%
CPI-Y/Y 0.5% 0.1%
Ex Food & Energy-Y/Y 0.1% 0.2%
Ex Food-M/M 0.0% 0.2%
Ex Food & Energy-M/M -0.1% 0.2%

Japan's consumer price index rose 0.5 percent year-on-year in November, up from an increase of 0.1 percent in October. The index was flat month-on-month, following an increase of 0.6 percent in October. This is the strongest year-on-year increase in the index this year, though the increase remains well below the Bank of Japan's inflation target of 2.0 percent.

Food prices were the main factor pushing up the year-on-year increase in headline CPI. Food prices rose 3.6 percent year-on-year in November, up from an increase of 2.3 percent in October. Looking at food prices in more detail, the stronger price increase was mainly driven by fresh food prices. Excluding this category, food price inflation actually moderated from 0.6 percent in October to 0.5 percent in November.

This impact can be seen in the core CPI index, which excludes fresh food prices. In contrast to headline CPI, this index fell 0.4 percent year-on-year in November after dropping by the same magnitude in October. In month-on-month terms, the core CPI index was also flat after an increase of 0.2 percent in October.

Weak energy prices also remain a drag on both the headline and core CPI indices these prices fell by 6.7 percent year-on-year in November after a decline of 7.9 percent in October. The so-called "core core" CPI index, which excludes the prices of energy and all food items, fell 0.1 percent on the month and rose 0.1 percent on the year in November, after an increase of 0.2 percent on the month and the year in October.

Officials at the Bank of Japan argue that both the core and core-core CPI measures understate the strength of underlying inflation pressures in Japan. Their preferred measure of core inflation excludes energy prices and the prices of fresh food, but retains the prices of manufactured and other processed food products which, they argue, are less volatile than fresh food prices. This index rose 0.3 percent year-on-year in October, up from 0.2 percent in September but well below levels seen earlier in the year. The BoJ will publish an estimate for November soon.

Today's inflation data show that key measures of price changes remain heavily influenced by fresh food and energy, with prices for other categories of consumer spending either falling or recording only moderate increases in year-on-year terms. This is broadly consistent with the assessment of officials that price pressures are likely to remain subdued in the near-term and that their inflation target is not likely to be met until sometime in the fiscal year ending March 2019.

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.