What's going on?

According to separate gauges released on Friday, prices are rising more slowly in the US than during previous months this year and inflation in the eurozone remains low � but it�s not having the effect on markets that investors would typically expect!

What does this mean?

The US Federal Reserve�s (�the Fed�) preferred gauge of inflation showed that, excluding volatile components like the price of energy, prices rose 1.4% in May � down from the 1.8% reading it hit in February.

In the eurozone, �core� inflation (e.g. excluding energy) actually rose, but only to 1.1%. Both the Fed and the European Central Bank (ECB) target inflation of about 2% (see why below). Friday�s data was a reminder of how far away both economies still are relative to their targets.

Why should I care?

The bigger picture: Lower inflation should mean less pressure to increase interest rates�

Central banks, like the Fed and the ECB, typically want inflation to be around 2%, which they view as the rate that is most supportive of economic growth (click here for more background). In order to achieve higher inflation, they may lower interest rates to spur activity (e.g. cheaper borrowing tends to lead to more spending, thereby driving up prices). With inflation still tepid, investors would typically think that central banks would be hesitant to raise interest rates…


For markets: But, central banks are signaling that they might raise interest rates anyway.

The Fed has raised its target interest rate three times in the past seven months and appears determined to continue to take action to push them up further. Last week, the ECB suggested that it too was more likely to allow interest rates to rise. This may be because they think that more inflation is coming, or perhaps they simply want the space to cut interest rates again when the economy slows down. But, whatever the reason, stocks are having a tough time and bonds are selling off sharply as central bankers hint at pushing up interest rates.