Price cuts trigger inflation fall

However, the cost of living is still rising dramatically, just at a slower pace than previously.

The retail prices index (RPI) rate of inflation, which includes housing costs, dropped from 5.2% in November to 4.8% in December, the Office for National Statistics (ONS) says.

Key Points

• RPI falls from 5.2% in November to 4.8% in December

• CPI dropped to 4.2% in December from 4.8% in November

• Largest drop in inflation in nearly three years

Meanwhile, the consumer prices index (CPI) rate of inflation dropped to 4.2% in December from 4.8% in November, equal to the decline between March and April 2009.

The drop was driven by a 2.8% plunge in the price of clothing and footwear as retailers slashed prices to pull in more customers in the run-up to Christmas.

But there is less evidence than expected of the impact of the supermarket price war that started in early October, as food prices rose by 1.4% month on month.

Further falls 'likely'

The drop in the rate of inflation in December underlines the easing pressure on households after a sustained period of high prices and slow wage growth.

The Bank of England, in its last inflation report, in November, said it expects the rate of inflation to fall back gradually through 2012.

The increase in the cost of living is expected to slow further as the economy grinds to a halt and unemployment soars towards the 3 million mark.

December's figures and any further slowdown in inflation will support the argument in favour of holding interest rates at record lows of 0.5% and injecting billions of pounds into the Bank's quantitative easing (QE) programme, which is the printing of money.

Looking ahead, Chris Williamson, chief economist at financial information services company Markit, says: "Further falls are likely in coming months, reducing the squeeze on incomes seen last year and therefore providing a much needed boost to economic growth in 2012."

Drop in fuel and clothing prices

Elsewhere, the ONS says downward pressure came from fuel prices, which dropped 0.6%, and alcoholic drinks, which fell 1.5% between November and December.

The fall in clothing prices was driven by a wide range of garments, with a particularly large drop in women's outerwear, the ONS says.

The retail sector has been one of the most apparent victims of last year's consumer spending squeeze as a string of businesses closed stores or fell into administration.

There was some upward pressure last month with the largest price increases coming from mobile phone charges, rising 1.3%.

Vicky Redwood, economist at Capital Economics, says today's figures paved the way for a further increase in QE next month.

She says: "Obviously these falls in inflation will help to alleviate the squeeze on households' real pay, but the deteriorating labour market and tightening credit conditions will maintain the downward pressure on consumer spending this year."