January 4, 2017 04:00 CST

Consensus Actual Previous
Year over Year 1.0% 1.1% 0.6%

Eurozone inflation last month finally moved back above the 1 percent mark. At a provisional 1.1 percent, the annual rate was up 0.5 percentage points versus its final November print and slightly firmer than expected. It also equalled its highest level since August 2013.

Crucially, the underlying picture improved too, albeit much less sharply. Hence, both the rate excluding energy, food, alcohol and tobacco and omitting just energy and unprocessed food edged a tick firmer to 0.9 percent. This was the first rise in former since June and the second successive increase in the latter. That said, the new rate is only back to where it was earlier in the year so hardly constitutes a major break higher.

Indeed, most of the headline gain was attributable to sharply stronger inflation in energy where the rate jumped from minus 1.1 percent to 2.5 percent, and food, alcohol and tobacco, which saw a 0.5 percentage point bounce to 1.2 percent. Significantly, non-energy industrial goods were only flat at 0.3 percent and services just 0.1 percentage points higher at 1.2 percent.

So, while welcoming the flash December HICP data the ECB will also be fully aware that underlying developments remain worryingly weak. Following last month's statement, monetary policy looks set for the time being. Even so, there must remain at least some risk of additional easing should the Eurozone economy fail to acquire the momentum needed to ensure that today's cautiously promising news is not just a flash in the pan.

The flash harmonised index of consumer prices (HICP) provides an early gauge of the final HICP but using just partial data. Only the EU and Eurozone aggregate statistics are released at this stage, not figures for individual member states. In addition, only the annual (not the monthly) inflation rate is reported and subsector information is also limited. Changes in the index provide an estimate of inflation, as targeted by the European Central Bank (ECB). Final data are released a round two weeks later.

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.