Headline inflation fell sharply in December. A provisional 9.2 percent annual rate was well down on November's final 10.1 percent and 0.3 percentage points short of the market consensus. The decline, which reflected a 0.3 percent monthly fall in prices, left the yearly rate at a 4-month low but still some 7.1 percentage points above the ECB's 2 percent target.

Indeed, in line with November, the deceleration in the overall rate was not mirrored in the key core measures. Hence, the narrowest gauge rose from 5.0 percent to 5.2 percent while the broader index which excludes just energy and unprocessed food climbed from 6.6 percent to 6.9 percent. Both outturns were new all-time highs. More generally, the rate for non-energy industrial goods increased from 6.1 percent to 6.4 percent while its services counterpart rose from 4.2 percent to 4.4 percent. Energy (25.7 percent after 34.9 percent) subtracted significantly but food, alcohol and tobacco (13.8 percent after 13.6 percent) again provided a boost.

Regionally, inflation rates were down across the board apart from Slovenia (unchanged at 10.8 percent) and Malta (7.3 percent after 7.2 percent). France (6.7 percent after 7.1 percent), Germany (9.6 percent after 11.3 percent), Italy (12.3 percent after 12.6 percent) and Spain (5.6 percent after 6.7 percent) all recorded sizeable headline declines. Elsewhere, Latvia (20.7 percent) remained at the top of the inflation ladder ahead of Lithuania (20.0 percent).

Today's update will not please the ECB. With increasing focus on underlying developments, the acceleration in the core rates will be seen as a further sign that inflation is becoming more entrenched. Key interest rates will certainly be headed north again in February and probably by another 50 basis points. Today's suite of data puts the Eurozone's ECDI at 24 and the ECDI-P at 35, both measures indicating overall economic outperformance versus expectations.

Consensus for December's HICP flash is 9.5 percent and 5.0 percent for the narrow core. These would compare with 10.0 and 5.0 percent in November.

The flash harmonised index of consumer prices (HICP) provides an early estimate of the final HICP, but using just partial data. 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 Eurozone is the harmonized index of consumer prices (HICP) 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 Eurozone, 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.