Inflation again easily undershot expectations in December. Prices are seasonally firm at year-end so a provisional 0.8 percent monthly fall was steep enough to slash headline annual inflation from 10.0 percent to 8.6 percent. This was fully 0.5 percentage points short of the market consensus and the lowest reading since August (7.9 percent).

The flash HICP painted a similar picture, declining a sharper 1.2 percent versus November to reduce its yearly change from 11.3 percent to 9.6 percent. This was still fully 7.6 percentage points above the ECB's target but well down from October's record 11.6 percent.

Within the CPI basket, inflation in overall goods fell from 17.1 percent to 13.9 percent, but in large part this was due to much weaker energy (24.4 percent after 38.7 percent). For once, food (20.7 percent after 21.1 percent) also subtracted, albeit not by very much, but services (3.9 percent after 3.6 percent) climbed sharply. Consequently, core inflation (ex-food and energy) which stood at 5.0 percent in November might have risen slightly.

Taken together with the flash Spanish HICP already released (5.6 percent after 6.7 percent), today's surprisingly soft German update suggests that headline Eurozone inflation will also drop steeply in Friday's flash report. However, the signs are that the core rate will be much stickier. Weighed down by today's data, the German ECDI now stands at minus 2 but, at 27, the ECDI-P indicates that, in general, real economic activity continues to exceed forecasters' predictions.

December's consensus is a 9.1 year-over-year rate versus 10.0 percent in November.

The consumer price index (CPI) is a measure of the average price level of a fixed basket of goods and services purchased by consumers. Monthly and annual changes in the CPI provide widely used measures of inflation. A provisional estimate, with limited detail, is released about two weeks before the final data are reported.

The consumer price index is the most widely followed indicator of inflation. An investor who understands how inflation influences the markets will benefit over those investors that do not understand the impact. In countries such as Germany where monetary policy decisions rest on the central bank's inflation target, the rate of inflation directly affects all interest rates charged to business and the consumer. As a member of the European Monetary Union, Germany's interest rates are set by the European Central Bank.

Germany like other EMU countries has both a national CPI and a harmonized index of consumer prices (HICP). The HICP is calculated to give a comparable inflation measure for the EMU. Components and weights within the national CPI vary from other countries, reflecting national idiosyncrasies. The preliminary release is based on key state numbers which are released prior to the national estimate. The states include North Rhine-Westphalia, Baden-Wuerttemberg, Saxony, Hesse, Bavaria and Brandenburg. The preliminary estimate of the CPI follows in the same day after the last of the state releases. The data are revised about two weeks after preliminary release.

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. 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.