Tue Oct 31 05:00:00 CDT 2017

Consensus Actual Previous
Year over Year 1.5% 1.4% 1.5%

Eurozone inflation was provisionally weaker than expected this month. At 1.4 percent, the headline annual rate was a tick short of its readings in both August and September and at its lowest mark in three months. This was its first decline since June.

More worryingly, the core measures were even softer. Hence, excluding energy, food, alcohol and tobacco, the yearly rate dropped 0.2 percentage points to just 0.9 percent, equalling its lowest outturn since March. Similarly, omitting just energy and unprocessed food the rate was off 0.2 percentage points at 1.1 percent, its weakest print since May. The main reason for the overall deceleration was services where inflation declined from 1.5 percent to 1.2 percent. The non-energy industrial goods rate was 0.1 percentage points lower at 0.4 percent. Energy (3.0 percent after 3.9 percent) also subtracted while food, alcohol and tobacco (2.4 percent after 1.9 percent) provided the only real boost.

The ECB must be disappointed by the reversal in underlying inflation and will see today's outcome as further justification for its new open-ended 2018 QE programme. As the flash GDP report shows (see today's calendar entry), the real economy is performing about as well as could be realistically expected but any significant inflationary impulse from domestic demand still seems some way off.

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.