June 29, 2017 06:30 CDT

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

Japan's consumer price index increased by 0.4 percent on the year in May, unchanged from the rate recorded in April. Year-on-year increases in headline CPI have now been in positive territory for eight consecutive months but remain well below the Bank of Japan's 2.0 percent inflation target. Seasonally adjusted headline CPI was flat on the month in May.

Core CPI, which excludes fresh food prices, picked up to 0.4 percent in May from 0.3 percent in April, in line with the consensus forecast. This measure of inflation has now been in positive territory for four consecutive months after year-on-year declines over almost all of 2016. This index was also flat on the month in May in seasonally adjusted terms.

The Bank of Japan's preferred measure of underlying inflation, CPI excluding fresh food and energy prices, was unchanged on the year in May after zero change in April. This index rose by a seasonally adjusted 0.1 percent on the month.

The BoJ's preferred measure of inflation shows that underlying price pressures in Japan remain very weak. This is broadly consistent with BoJ forecasts for inflation to pick up only gradually and for the target to be reached sometime in the fiscal year ending March 2019. Earlier this month BoJ Governor Haruhiko Kuroda noted that wage growth remained modest despite an improvement in the economy's output gap and stressed that it will take time to change consumers' "deflationary mindset".

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.