CPI figures for December showed a much smaller decline than expected, probably reflecting sterling’s plunge during 2008 and an associated surge in manufactured import prices – up 14% in the year to November.

Annual CPI inflation fell to 3.1% from 4.1% in December but would have risen but for the VAT cut and lower energy costs. The Office for National Statistics estimates that the Pre-Budget Report tax changes would have subtracted 1.3 percentage points from the annual rate if passed on in full. It also reports that around two-thirds of prices collected in shops had been reduced, either at the shelf or the till, to reflect the lower VAT rate in December. This suggests that annual CPI inflation was depressed by 0.8-0.9 pp (two-thirds of 1.3).

A further negative impact, of 0.3 pp, came from lower energy prices. So annual CPI inflation would probably have risen from 4.1% to 4.2-4.3% without the VAT cut and a slump in world energy costs.

The VAT cut also accounts for the fall in annual “core” inflation – excluding energy, food, alcohol and tobacco – from 2.0% to 1.1%. The ONS estimate of the full CPI effect implies a reduction of 1.7 pp in the annual core rate in the event of full pass-through, or 1.1 pp with a two-thirds adjustment. This suggests annual core inflation would have risen from 2.0% to 2.2% – the highest since September – in the absence of the VAT cut.