Relief for Sir Mervyn as inflation takes a tumble

The sharp fall in the Consumer Prices Index from 4.2% to 3.6% came as the impact of last January's VAT hike largely dropped out of the figures, promising easier times ahead for strained household budgets. Recent price cuts by the UK's big six energy firms, which all raised charges last year, will help drive down inflation further in the months ahead.

January's fall takes the CPI to its lowest level since November 2010. Alongside VAT, petrol costs were a big driver, after rising far more slowly than a year ago. The Governor was still forced to write his 14th open letter to Chancellor George Osborne because CPI still stands well above the Bank's 2% target, but he stressed that inflation should be back on target by the end of 2012. He emphasised that the main fear of rate-setters remained risks to growth from the eurozone after the Bank voted to pump an extra £50 billion into the economy through quantitative easing last week.

King wrote that inflation "will continue to fall back to around the target by the end of 2012" although the pace of the fall remained uncertain as tensions in the Middle East threatened a fresh spike in oil prices.

The broader Retail Prices Index measure also fell back, to 3.9%, and "core" inflation - stripping out volatile food and energy costs - fell to 2.6%. Osborne replied: "Although inflation is now falling as expected, the process of rebalancing (the UK economy) has a long way to go."

Andrew Goodwin, senior economic adviser at the Ernst & Young ITEM Club, said: "We've been waiting for these figures in the anticipation that they would help to emphasise the importance of the temporary factors that kept inflation high throughout last year. They didn't disappoint."

ING Bank's James Knightley added that inflation could be closer to 1% than 2% by the end of the year as a weak economy drove down prices.

He said: "Weak corporate pricing power in an environment of subdued economic activity will also keep inflation moving lower. Indeed, we suspect CPI could fall to nearly 1% in the final quarter of 2012."

This could even leave the Governor at risk of having to write to the Chancellor for undershooting the inflation target by more than 1 percentage point.