City analysts’ expectations were well exceeded and resulted prices falling by 0.8%. Falling air fares, food prices and telephone charges helped pull inflation down as well.
This will help allay fears that the Bank will increase interest rates in the coming months in an attempt to keep inflation closer to 2%. Sharp drops in oil prices and utilities including British Gas means inflation will fall further, although oil looks set to increase to $60 a barrel.
The CPI has been above its target since May 2006 and the Banks governor was close to having to explain himself to the Chancellor, as the target of 2% must not be exceeded by 1% either way, as stipulated in the rules of the Bank’s independence. The RPI has also fallen from 4.4% to 4.3% in December partly due lower fuel, and furniture costs in the previous month’s sales, whilst tobacco sales created slight upward pressure.
Gas and electricity price cuts are likely to restore the CPI to its target sometime in the middle of the year, which will go some way to calming the nerves of the Bank’s committee. However there are worries that the higher RPI will filter into the next pay round, resulting in last year’s inflation rise become entrenched, making it more difficult to return to the target of 2%.