This was not at all a surprise because inflation is measured by a month twelve moving average. This means that the price rises that occurred in January 2011 dropped out of the index and were replaced by price rises in January 2012.
In January 2012 VAT rose by 2.5% (from 17.5% to 20%). As VAT remained at 20% last month the whole effect of that rise was removed. Given that the small fall in CPI, by 0.8%, might seem rather modest.
The fall in inflation is welcome news for households who have found wages rising less quickly than the general level of prices.This erosion of real living standards has inevitably affected consumption and so aggregate demand.
Inflation is forecast to fall to around 2% by the end of the year. This will help, but only if incomes rise by at least 2%. Britain continues to grow slowly and today Moody's cast doubt on the UK's ability to keep its AAA credit rating because of the poor growth rate.
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