October 26, 2017 06:30 CDT

Consensus Actual Previous
Ex Food-Y/Y 0.8% 0.7% 0.7%
CPI-M/M 0.0% 0.2%
CPI-Y/Y 0.7% 0.7%
Ex Food-M/M 0.0% 0.1%
Ex Food & Energy-M/M 0.0% 0.1%
Ex Food & Energy-Y/Y 0.2% 0.2%

Japan's consumer price index increased by 0.7 percent on the year in September, unchanged from the increase recorded in August and still well below the Bank of Japan's 2.0 percent inflation target. Seasonally adjusted headline CPI was flat on the month in September after an increase of 0.2 percent in August.

The stability in the year-on-year change in the headline index in September reflects offsetting moves in price changes for some of the major categories of consumer spending. Fuel, light and water charges advanced 6.0 percent on the year in September, up from 5.2 percent in August, while food prices also recorded a slightly stronger year-on-year increase of 1.0 percent, up from 0.9 percent in August. Transport and communication costs were flat on the year in September after falling by 0.4 percent in August. These stronger price changes were partly offset by a 0.3 percent year-on-year decline in prices of clothes and footwear after an increase of 0.6 percent in August. Housing costs fell by 0.2 percent on the year in September, as they did in August.

Core CPI, which excludes fresh food prices, also increased by 0.7 percent on the year in September, unchanged from August and just below the consensus forecast of 0.8 percent. This measure of inflation has been trending higher gradually over the last twelve months and has been in positive territory since the start of the year after year-on-year declines over almost all of 2016. This index was flat on the month in September in seasonally adjusted terms after an increase of 0.1 percent in August.

The Bank of Japan's preferred measure of underlying inflation, CPI excluding fresh food and energy prices, rose 0.2 on the year in September, unchanged from August. This index also rose 0.2 percent on the month on a seasonally adjusted basis after increasing by 0.1 percent in August.

Today's data show all three main measure of inflation were unchanged in September with monthly price changes also very weak, highlighting the challenges officials continue to face in meeting their inflation target. In the BoJ's most recent outlook report, published in July, officials forecast the year-on-year change in the consumer price index (excluding fresh food) to be 1.1 percent in the current fiscal year and 1.5 percent next fiscal year. Excluding the impact of a planned sales tax increase, this measure of inflation was forecast to be 1.8 percent in the fiscal year starting April 2019. Based on these revised inflation forecasts, the BoJ currently expects to meet its inflation target sometime "around" the fiscal year starting April 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.