UK inflation fell at its sharpest rate for nearly three years in December 2011, leading to rumours of further quantitative easing (QE).

The Consumer Price Index (CPI) fell from 4.8 per cent to 4.2 per cent, the biggest drop since April 2009, while the Retail Price Index dropped from 5.2 per cent to 4.8 per cent.

The Office for National Statistics noted that the biggest downward pressures on inflation were falling petrol, gas and clothing prices.

The Bank of England (BoE) has always predicted that inflation would fall this year as declining consumer demand forces shops to cut prices.

The BoE Monetary Policy Committee’s (MPC) target for inflation is 2 per cent and the sharp drop has increased expectations that the central bank will expand its QE programme by about £50 billion, to both control the decline in inflation and to boost the flagging economy.

Vicky Redwood, chief economist at Capital Economics, commented, ‘The MPC was already expected to announce more QE at next month’s meeting, but these figures make that even more likely.

‘Inflation in the fourth quarter as a whole averaged 4.7 per cent, in line with the Bank of England’s last set of forecasts – which also projected inflation to fall below its target at the policy horizon. Indeed, we still think that inflation will drop to just 1 per cent or so by the end of this year.’

However, Redwood warned that despite the drop in inflation reducing the squeeze on household income, ‘weakening labour market and tighter credit conditions will maintain the downward pressure on consumer spending’.

She forecast that the UK will still fall into, and may in fact already be in, a recession this year.