The VAT reduction and early Christmas discounting on the high street are expected to have seen another steep fall in inflation when official figures are released later today.
Experts are predicting that Consumer Prices Index (CPI) inflation was pulled sharply back last month, to as low as 2.6% from 4.1% in November.
The fall is set to be one of the biggest monthly moves ever recorded by the Office for National Statistics
(ONS) and is set to heighten deflationary fears.
It comes after CPI fell to its lowest level since June in November as a result of hefty falls in fuel costs thanks to significantly lower oil prices.
It is thought that the December ONS figures will also show a significant impact from the Government's VAT decrease from 17.5% to 15% at the beginning of December.
The ONS estimated last month that if passed on fully, the VAT move could wipe off around 1% to 1.3% from CPI.
Pre-Christmas discounting from retailers desperate to lure in shoppers is also likely to have pulled inflation back further towards the Government's 2% target.
While policymakers have been striving to bring inflation back down to target after last year's fuel price bubble, it is now feared that the impending recession could see CPI fall too far below the 2% goal and possibly lead to a period of deflation.
The Bank of England was handed important new powers in the Government's latest bank rescue package outlined yesterday, which could help it in the fight against deflation.
As interest rates – already at a historic low of 1.5% – are expected to come down close to zero, the Bank's Monetary Policy Committee (MPC) will need to look at alternative tools to use.
The Government yesterday announced a new £50 billion fund for the Bank to purchase private sector assets, which could make it easier for businesses to borrow and therefore spend, boosting the economy and easing inflation back up.
Bank governor Mervyn King is likely to flesh out more details on the scheme in a speech this evening.
And in a busy week for economic news, minutes of the MPC's rates meeting earlier this month will also be released tomorrow.
The Bank has already said that the pound's weakness came into its thinking when it lowered rates by a more muted half point to a 315-year low of 1.5%.
But voting patterns among the Bank's Monetary Policy Committee will be of particular interest for the history-making decision.
The minutes will then be followed on Friday by output figures for the final three months of 2008, which are forecast to signal the official start of the UK recession.
