Shopkeepers who bolstered margins last month by not passing on chancellor Alistair Darling’s VAT cut were blamed yesterday for a smaller drop in inflation than many economists expected.
National Statistics said only two-thirds of shop prices had been cut to reflect the temporary cut in VAT to 15 per cent from 17.5.
Year-on-year inflation measured by the Consumer Prices Index – the benchmark for the Bank of England’s two per cent target – fell to 3.1 per cent in the year to December down from 4.1 in November, the steepest monthly drop for more than 16 years.
The biggest factor was the VAT cut, but it was reinforced by a fall of 6p a litre in petrol between November and December to an average of 89.2p. That stood against a 1.7p increase in December, 2007.
Diesel prices fell 6.4p a litre last month to 89.2p, while they rose by 3p the previous December.
The Retail Prices Index, which includes the costs of owning and buying a home – left out of the CPI – fell more sharply to 0.9 per cent over the 12 months to December from three per cent a month earlier.
Cuts in mortgage interest and falling house prices accounted for the difference between the indices. It will result in very modest increases for pensioners in company schemes whose annual increase is based on December RPI. Since few pensioners have mortgages or are in a position to benefit from lower house prices, many will find their standard of living squeezed.
Research by Alliance Trust shows for the over-75s the cost of living is 5.9 per cent higher than in December 2007, largely because they spend nearly seven per cent of their money on gas and electricity bills, which have not fallen from peaks last summer.
“The elderly continue to be hit as they spend a higher proportion of their budget on utility costs and food, both of which have soared over the past year,” said Shona Dobbie head of the Alliance Trust Research Centre. “The younger age group are benefiting from rapid falls in audio visual and clothing prices, which are pulling their inflation rates down.”
Prices of clothes and footwear fell 10.3 per cent in 2008, while “core” CPI inflation, not counting energy, food, alcohol and tobacco, fell to 1.1 from two per cent, lower than at any tine since July, 2006.
Jonathan Loynes of Capital Economics, commented: “The weakness of core inflation and further downward pressure likely to result from the opening of slack in the economy points to a growing danger of a more fundamental and longer-lasting period of deflation ahead.”
Hetal Mehta at the Ernst & Young ITEM Club said: “Although the dramatic depreciation of sterling will help moderate the fall in inflation, further sharp falls are expected over coming months, with RPI inflation possibly entering negative territory within a couple of months.”