January 31, 2017 04:00 CST

Consensus Actual Previous
Year over Year 1.6% 1.8% 1.1%

Eurozone inflation proved rather stronger than expected this month. At a flash 1.8 percent, the annual rate was up fully 0.7 percentage points from its final December reading and at its highest mark in four years.

However, once again the swing in the headline data was all but wholly attributable to the more volatile components. Hence, excluding energy, food, alcohol and tobacco, the HICP posted a 0.9 percent yearly rate, unchanged from its final December print and 0.1 percentage points below its outturn in January 2016. Omitting just energy and unprocessed food, the results were exactly the same. Rather, the acceleration was essentially due to higher rates in energy (8.1 percent after 2.6 percent) and food, alcohol and tobacco (1.7 percent after 1.2 percent). Non-energy industrial goods recorded a 0.5 percent rate, up a couple of ticks from last time but, ominously, services inflation dipped a notch to 1.2 percent.

In other words, underlying developments this month were essentially unchanged from December. The ECB has stressed that it will look through the short-term peaks and troughs caused by energy prices so it cannot be overly impressed with today's report. That said, it will hope that the marked acceleration in headline inflation will provide a boost to inflationary expectations. If so, and combined with a tightening labour market, this could yet see the core rate begin to trend higher before too long.

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.