Eurozone inflation decelerated sharply in May. At 6.1 percent, the flash annual rate was down nearly a full percentage point versus April's final 7.0 percent and at its lowest level since February 2022. However, while weaker than the market consensus, the latest reading is still some 4.1 percentage points above the ECB target.

More importantly anyway, the slide in the headline rate was only partially mirrored in the core rates. Hence, the narrowest measure fell (a still significant) 0.3 percentage points from April's final 5.6 percent to 5.3 percent, matching its lowest mark so far in 2023. Excluding just energy and unprocessed food, the rate dropped from 7.3 percent to 6.9 percent. Elsewhere, inflation in non-energy industrial goods decreased from 6.2 percent to 5.8 percent and in services from 5.2 percent to 5.0 percent. Energy (minus 1.7 percent after 2.4 percent) and food, alcohol and tobacco (12.5 percent after 13.5 percent) also had a negative impact.

The ECB will no doubt be hopeful that the sizeable drop in headline inflation will help to temper inflation expectations across the economy in general. It should also look favourably at the steeper than anticipated decline in the core rates. Nonetheless, the underlying picture is still worryingly firm and inconsistent with the bank meeting the 2 percent inflation target on a sustainable basis anytime soon. As such, another 25-basis point increase in key interest rates remains firmly on the cards later this month.

Today's update puts the Eurozone ECDI at minus 34 and the ECDI-P at minus 23, both measures indicating that overall economic activity continues to run cooler than market expectations.

Consensus for May's HICP flash is 6.4 percent and 5.5 percent for the narrow core. These would compare respectively with April's 7.0 percent, which edged higher in the month, and 5.6 percent, which edged lower.

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.