Jan 20, 2009
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Clothes and sales tax cut curb inflation

Jan 20, 2009

By David Milliken and Christina Fincher

LONDON (Reuters) - Inflation fell by its biggest amount in almost 17 years thanks to a cut in sales tax and because retailers had to slash prices in one of the worst Christmas shopping seasons on record.

The annual rate of CPI inflation dropped a full percentage point to 3.1 percent in December, the biggest drop since April 1992, the Office for National Statistics said on Tuesday. Nevertheless, that was still well above the Bank of England's 2 percent target and analysts' forecasts of 2.7 percent.

"But it's still a significant fall in inflation. I don't think it changes the bigger picture: we're heading for deflation technically around the middle of this year," said Ross Walker, UK economist at RBS.

"It leaves us on a course for a half-point (interest rate) cut in February with risks for a bigger reduction."

Treasury minister Stephen Timms told the BBC that the data showed inflation was likely to be near the 2 percent target on average next year, but could dip as low as zero before then.

The Bank of England has already cut interest rates to a record low of 1.5 percent and is expected to to make further reductions in the months ahead.

Data to be published on Friday is expected to show the British economy in recession for the first time since 1992.

Bank of England Governor Mervyn King is expected later on Tuesday to outline how the central bank might use its new power to buy high-quality assets when he makes his first major speech of the year.

The plans were announced on Monday when the government unveiled a second multi-billion pound rescue package for its banks in three months to try to get lending flowing to business.


Britain's above-forecast inflation bucks the trend of other European countries, where economists have underestimated the pace of price decline but forecasting was complicated by the cut in sales tax that took effect from December 1.

The ONS said around two thirds of shops passed on the cut to consumers, as did almost all internet retailers, but relatively few firms in the services industry followed suit.

Nonetheless, heavy discounting by clothing stores showed up clearly in the data, with the cost of clothing and footwear 10.3 percent lower than December 2007, the biggest decline since records began in 1989.

As recession looms, retailers have been attempting to lure people into their shops by slashing prices.

Luxury goods group Burberry said on Tuesday that strong promotional activity helped lift its sales but dented margins in December and predicted that the trend would continue into 2009 given the "difficult environment."

Meanwhile pubs group JD Wetherspoon, which recently slashed one of the beers it sells to 0.99 pounds a pint, said underlying sales rose 2.6 percent in the 12 weeks to January 18.

"Customers are becoming more discerning," JD Wetherspoon Chairman Tim Martin told Reuters. "This last half year has been our busiest ever."

(Editing by Ian Jones)

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