Thu May 31 04:00:00 CDT 2018

Consensus Actual Previous
Year over Year 1.6% 1.9% 1.2%
Underlying HICP y/y 1.0% 1.1% 0.7%

Eurozone inflation bounced sharply this month. At 1.9 percent, the annual flash reading was fully 0.7 percentage points above its final April reading, much stronger than expected and equalled its highest rate since February 2017. In addition, it also moved back to its near-2 percent medium-term target.

Crucially, the core rates accelerated significantly too. The narrowest measure, which excludes energy, food, alcohol and tobacco, saw its yearly gain jump 0.4 percentage points to a marginally firmer than anticipated 1.1 percent. This just more than reversed April's drop and matched the strongest print since last August. Omitting just energy and unprocessed food, the rate was up a smaller 0.2 percentage points at 1.3 percent, in line with its March outturn.

Energy (6.1 percent after 2.6 percent) did much to lift the headline print and food, alcohol and tobacco (2.6 percent after 2.4 percent) also made a positive contribution. Services (1.6 percent after 1.0 percent) more than made up for April's decline but non-energy industrial goods (0.2 percent after 0.3 percent) moved the other way.

The ECB will be pleased, and not a little relieved, with the sharp acceleration in consumer prices this month. However, the data need to be put into context. May 2017 was unusually soft (both the headline and narrow core HICP fell 0.1 percent on the month) and there may still be some residual Easter effects. Even now, the narrow underlying rate is still essentially trending only sideways. Consequently, the central bank is likely to remain quite cautious in its updated economic forecasts at next month's policy setting meeting. Today's report may increase the chances of ending the asset purchase programme in September but it certainly does not guarantee it.

The flash harmonised index of consumer prices (HICP) provides an early estimate 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, just 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. Over the short-term, the central bank focusses on a number of core measures which seek to strip out the most volatile components and so give a much better guide to underlying developments. Two of these are made available in the flash report amongst which financial markets normally concentrate upon the narrowest which excludes energy, food, alcohol and tobacco.

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.