UK inflation falls by most since 1992

Prices fell for a third month in a row in December, registering the biggest monthly drop since 1992.

The consumer price index fell to an annual rate of 3.1 per cent last month – compared with 4.1 per cent in November – and reached its lowest level since April, the Office for National Statistics reported.

But inflation was still higher than the 2.7 per cent that economists had forecast as food prices remained sharply higher than a year ago.

The ONS said a cut in value added tax from 17.5 per cent to 15 per cent made the largest contribution to the drop in inflation, although falling petrol prices and bigger sales in stores over December than in the previous year also played a part. The statistics office said about two-thirds of prices at shops had been reduced to reflect the VAT cut. Clothing and footwear showed the sharpest drops in prices – down 10.3 per cent over the 12 months to December.

The retail price index, which includes mortgage interest payments and house prices, fell to 0.9 per cent from 3 per cent in November, the biggest drop in almost 30 years. The RPI is important as pay and benefit increases are linked to it.

Inflation rates are expected to continue a rapid decline as energy prices fall, culminating in a period of deflation later in the year.

“We do not regard sustained deflation for the UK as likely, chiefly because the weak pound will push up prices of imported goods quite sharply over time and hence prevent the overall price level falling on a sustained basis,” said Michael Saunders, economist at Citigroup.

Economists at JPMorgan predict that deflation in the CPI will begin in July and last for five months, while the RPI will be in negative territory throughout the year, with retail prices falling as much as 4.3 per cent in September.

The fall in prices will have boosted real incomes over the past few months, making consumer pounds go further. It will also bring some good news for pensioners after a year in which they have been hit by sharply rising fuel and food prices.

The economic outlook remains dismal. The European Commission forecast on Monday that the UK economy would contract 2.8 per cent this year, which would be the worst performance since at least 1946. Economists forecast that unemployment could top 3m.

The Bank of England said in its last inflation report that mounting job losses would more than offset the impact of falling prices on real incomes.