Inflation driven down by the ‘VAT effect’ and slowing oil price rises

The inflation rate has fallen 1.2 percentage points since November, the largest fall over two consecutive months in just over three years.

The figures showing inflation at 3.6 per cent, using the Consumer Price Index measure of inflation, were released a day ahead of the Bank of England’s quarterly inflation report, which is expected to confirm its belief that inflation will eventually hit its 2 per cent target and possibly fall further in early 2013.

Much of yesterday’s fall could be accounted for by the fact that the impact of last year’s VAT rise, which saw the levy go up from 17.5 per cent to 20 per cent in January 2011, was no longer evident in the figures.

The data adds further weight to the Bank’s decision last week to pump an extra £50 billion into the economy through its quantitative easing programme.

The VAT effect had a pronounced impact on transport costs, which applied the greatest downward pressure to overall prices in January, as they fell 0.7 per cent. The fall was also driven by softer rises in the cost of crude oil, which led to lower price increases in petrol and diesel, new car sales and maintenance. The average price of petrol at the pumps in January rose by 0.6p per litre, compared with a 5.4p rise last year, to £1.33 per litre. Diesel was up 0.7p, compared with a 5.8p rise, at £1.41 per litre.

The VAT hike also had a significant impact on the prices charged by restaurants and hotels, with costs little changed this year.

Food prices were broadly flat and had a slight downward impact on the overall rate. However, a softer drop in clothing and footwear prices provided some resistance to the fall in the overall rate of inflation.

Clothing costs fell by 4.9 per cent in January, compared with a 5.9 per cent drop in 2011.

Other measures of inflation also fell, with the retail prices index (RPI) dropping to 3.9 per cent in January from 4.8 per cent in December, its lowest level in just under two years.