Inflation falls again to 4.2%
The retail prices index (RPI) measure - which includes mortgage interest payments - also fell, from 5.2% in November to 4.8% in December.
CPI is now at its lowest rate since June 2011, with the fall attributed to lower fuel prices and cheaper clothing.
Ruthless price cutting
Ranvir Singh, chief executive of market analyst RANsquawk, believes the "ruthless price cutting" on the high street is to thank for the falling rate of inflation.
"Today's figures are of course welcome. But with most economists predicting further stagnation or even a technical recession in 2012, falling inflation may have little more than a palliative effect," he says.
He comments that with weak consumer demand, the pressure to keep prices down will continue, citing the recent price cuts from the 'big six' energy suppliers as evidence.
Singh adds: "While inflation is still well above the Bank of England's target level, such a big fall will make the the the governor much more inclined to dig out his quantitative easing (QE) gun from the cabinet once again.
"It's now highly likely that he'll announce a third dose of QE along with the Bank's next quarterly inflation report next month."
Tom Paterson, chief economist at Gold Made Simple, cautions that the lower figures are not a "green light" to begin another round of QE, adding that the energy companies and retailers' price cuts have "distorted inflation in the short term".
"There needs to be a degree of reflection before any immediate decisions are made to pump more money into the system," he says.
He adds: "Whilst we could well see inflation tick lower for the next few months, with the possibility of energy companies cutting prices further and retailers extending their discounting beyond the January sales, the possibility that CPI will be anywhere near the 2% target a year from now, as confidently predicted by the Bank of England, is a fanciful one."
"The best we can hope for is that inflation sees a steady but controlled decline over the next 12 months, ending the year at less painful levels."
Replaced as the official measure of inflation by the consumer prices index (CPI) in December 2003. Both the Retail Price Index and CPI are attempts to estimate inflation in the UK, but they come up with different values because there are slight differences in what goods and services they cover, and how they are calculated. Unlike the CPI, the RPI includes a measure of housing costs, such as mortgage interest payments, council tax, house depreciation and buildings insurance, so changes in the interest rates affect the RPI. If interest rates are cut, it will reduce mortgage interest payments, so the RPI will fall but not the CPI. The RPI is sometimes referred to as the “headline” rate of inflation and the CPI as the “underlying” rate.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
The Consumer Price Index is the official measure of inflation adopted by the government to set its target. When commentators refer to changes in inflation, they’re actually referring to the CPI. In the June 2010 Budget, Chancellor announced the government’s intention to also use the CPI for the price indexation of benefits, tax credits and public sector pensions from April 2011. (See also Retail Prices Index).