INFLATION hit its lowest level for nearly half a century in the 12 months until January, underlining the lack of confidence in the UK economy.
Experts warned that Britain was on course for deflation – an environment where prices are in freefall – as the retail price index which covers housing costs fell to 0.1 per cent from 0.9 per cent.
The official rate of inflation, the consumer price
index (CPI), had a more modest decline of 0.1 per cent to 3 per cent, figures from the Office of National Statistics showed. The lower retail price index was attributed to lower mortgage costs after the Bank of England slashed its base rate to just 1 per cent.
Vince Cable, the Liberal Democrats' Treasury spokesman, said that high council tax and food bills meant that lower prices were not yet a reality for many families.
But he added: "It is becoming clear that for the foreseeable future, there is a higher risk of deflation than inflation, which is why it is inevitable and sensible that the Bank of England should be moving towards expansion of credit and the money supply directly."
The ONS figures suggested the government's move to reduce VAT from 17.5 per cent to 15 per cent in December brought forward discounting on the high street, impacting the January inflation data.
Fuel prices continued to fall from last year's peak, plunging at the fastest pace on record in January, while recently announced gas and electricity bill reductions are also set to pull inflation lower.
Jonathan Loynes at Capital Economics said: "January's UK CPI figures revealed a smaller drop in inflation than expected, but don't preclude a further fall to zero and beyond over the coming months.
"The pressure on key high street goods prices is still strongly downwards and with these pressures set to intensify as consumer spending weakens further, and food and energy price inflation set to fall considerably further, we still expect CPI inflation to turn negative in the late summer/autumn," Mr Loynes added.
There are fears that deflation could lead to a rise in unemployment, as consumers put off buying goods and services.
Such price drops force the Bank of England to slash interest rates further, which in turn deters investors from putting their money into the UK.
Deflation can also be followed by a period of hyper-inflation, where sterling plummets to such a low level that imported goods become hugely expensive.
Despite the drop in inflation, Investec economist David Page said wage growth would not be pushed below 1 to 2 per cent, even if price-rise figures turn negative. "It will be very hard for firms to push through wages growth at a lower level than 1 per cent or 2 per cent," he said.
Not all prices dropped, however. Alcohol, holidays and toys became more expensive.
BACKGROUNDJANUARY'S slight fall in inflation will provide little comfort to savers who are struggling to stop the value of their deposits falling in real terms. The key Consumer Prices Index (CPI) measure of inflation dropped to 3 per cent last month from 3.1 per cent in December.
But despite inflation falling from its recent high of 5.2 per cent, with the Bank of England base rate at a record low of 1 per cent, savers are still struggling to get a real return on their money. Basic rate taxpayers need to earn interest of at least 3.75 per cent to stop the value of their savings falling once inflation and tax are factored in, while higher rate taxpayers need to earn a rate of 5 per cent. But figures from financial information website Moneynet.co.uk shows that the average interest rate paid on a variable rate savings account with a balance of £500 is now just 1 per cent.
