The consumer price index fell to an annual rate of 3.1 per cent last month, compared to 4.1 per cent in November, taking it back to April 2007 levels, the Office for National Statistics reported. But the annual rate was higher than the 2.7 per cent that economists had expected and was helped by recent changes to government fiscal policy.
The ONS said that the cut in VAT from 17.5 per cent to 15 per cent made the largest contribution to the drop in inflation, but that falling petrol prices, and bigger discounts in stores over December than in the previous year also contributed. It said that around two thirds of the prices at shops had been reduced to reflect the VAT cut.
The categories showing the sharpest declines were clothing and footwear, as the cut in VAT and high street sales fed through to lower prices. Prices of clothing and footwear were down 10.3 per cent over the 12 months to December.
Inflation rates are expected to continue a rapid decline in the coming months as energy prices fall further and last year’s rise in food prices drop out of the annual comparison. Mervyn King, Bank of England governor, said in a letter to the chancellor last month that, because inflation remained more than 1 percentage point away from the 2 per cent target, it was ”quite possible” he might soon have to write a letter explaining why inflation was too low.
The core level of CPI, which excludes energy, food, alcohol and tobacco, fell to 1.1 per cent from 2 per cent, its lowest since July 2006.
In response to fears of deflation setting in this year as jobs are lost and prices cut, and as interest rates get closer to zero, policymakers are being forced to consider unorthodox monetary policy. The Treasury on Monday provided a path for the Bank of England to create money to buy assets straight from banks and companies in order to stimulate demand, thereby pushing up inflation.
The retail price index, which includes housing costs and forms the basis for a range of pay and benefit increases, fell to 0.9 per cent from 3 per cent in November after the Bank of England cut interest rates sharply – the biggest one month drop since July 1980. It is forecast to fall below zero this year.