Bank is set to bring back QE as inflation turns the corner

The fall in the Bank's consumer prices index benchmark from 4.8% to 4.2% in December, driven by deep High Street price cuts and much smaller hikes in petrol prices than a year earlier, marks the start of a year of steeply falling inflation, easing the squeeze on household finances.

It also paves the way for Threadneedle Street to give another fillip to a struggling UK economy through quantitative easing next month.

Even bigger falls in the CPI are expected next month when the VAT rise to 20% a year ago, introduced by George Osborne to help tackle the deficit, falls out of the figures.

The Bank, which pumped another £75 billion into the economy last October in response to turmoil in the eurozone, could see inflation back to 2% by the end of this year, according to ING Bank's James Knightley.

"Given the growing threat of recession, further policy stimulus from the Bank is likely, starting with another £75 billion of gilt purchases in February.

"Indeed, we could see the size of the Asset Purchase Facility increase to nearly £500 billion, especially if the eurozone sovereign debt crisis is not resolved quickly or the euro suffers any departures, which would intensify the threat of recession," he added.

Stripping out volatile food, drink and energy prices there was also better news for the Bank's inflation watchers as the UK's underlying inflation slowed from 3.2% to 3%.

The City was expecting the inflation fall after the first drop in factory gate prices for 18 months last week, while the recent round of cuts by the "big six" energy companies will also lead to lower inflation.

The pound added half a cent against the dollar today but remained close to five-month lows against the greenback at $1.5375.

Despite the cheer on inflation, the Bank and the Chancellor will be braced for another rise in unemployment, currently 2.64 million, in gloomy jobless figures tomorrow. The independent Office for Budget Responsibility expects unemployment to peak at 8.7%, around 2.8 million, this year, and experts warn that the weakening jobs market is likely to close consumer wallets again just as the pressure from the rising cost of living is easing.

Vicky Redwood, chief UK economist at Capital Economics, said: "Despite the support from falling inflation, we still think that the economy will return to, and may already be in, recession."