March 2, 2017 05:30 CST

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

Japan's consumer price index increased by 0.4 percent year-on-year in January, up from 0.3 percent in December. Year-on-year increases in headline CPI have now been in positive territory for four consecutive months but remain well b below the Bank of Japan's 2.0 percent inflation target. Seasonally adjusted headline CPI rose 0.1 percent on the month in January after dropping 0.2 percent in December.

Core CPI, which excludes fresh food prices, rose 0.2 percent on the year in January, up from a fall of 0.2 percent in December. In seasonally adjusted terms, headline CPI rose 0.1 percent on the month in January while core CPI rose 0.3 percent.

Today's release includes a new measure of underlying inflation that is in line with the Bank of Japan's preferred measure. Previously, officials reported a measure of core inflation that excluded the prices of all food items and energy. The BoJ, however, argued that it is appropriate to exclude fresh food prices from this measure because these tend to be volatile but that the prices for processed foods, which tend to be less volatile, should be included. They also argued that excluding processed food prices tended to understate underlying price pressures.

From now, officials will report the BoJ's preferred measure of core inflation, which excludes energy prices and the price of fresh food but retains processed food prices. This measure of inflation, however, has been trending lower in recent months and fell again in January to zero percent from 0.1 percent in December.

This fall in the BOJ's preferred measure of inflation highlights that underlying price pressures remain very subdued in Japan. This is broadly consistent with the BoJ's assessment 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.