LONDON (AP) -- Britain's inflation rate fell to 3.6 percent in the year to January from 4.2 percent the previous month, official figures showed Tuesday, to the likely relief of cash-strapped households which have seen muted pay increases more than eaten up by rising prices.
The figure will also be welcome news for the government a day after ratings agency Moody's cut its outlook on the nation's AAA credit rating from "stable" to "negative" — the government has prided itself on using aggressive austerity to mantain investor confidence and its top credit rating.
The inflation data released by the Office for National Statistics was in line with expectations and put inflation below 4 percent for the first time since December 2010. A fall in fuel prices helped, as did the fact that last year's sales tax hike dropped out of the annual comparison.
The U.K. consumer price inflation (CPI) rate peaked at 5.2 percent in September.
Bank of England Governor Mervyn King said inflation is likely to be near the 2 percent target by the end of the year, although "the pace and extent of the fall in inflation remain highly uncertain."
"The unwelcome combination of sluggish growth and high inflation over the past two years is a reflection of the need for the economy to rebalance following the financial crisis and associated deep recession, together with rises in the costs of energy and imports," King said in a letter he is required to write to the government every quarter in which inflation is more than 1 percentage point above or below target.
"Although inflation is now falling broadly as expected, the process of rebalancing still has a long way to go. Growth remains weak and unemployment is high."
In its report on Britain's credit rating, Moody's Investor Service said the U.K. economy remains vulnerable to a deterioration in European economic and financial conditions.
Though inflation has been running above the 2 percent target since December 2009, rate-setters have kept borrowing costs at the record low base rate of 0.5 percent and recently approved another monetary stimulus in response to falling output — recent figures showed the U.K. economy contracted 0.2 percent in the last three months of 2011.
The central bank has held its policy line despite elevated inflation rates, arguing that price pressures would diminish this year. Markets will be interested to see if Wednesday's quarterly economic projections from the Bank of England show inflation falling below target later this year.
Many economists think that's a distinct possibility and that the Bank will back even more stimulus in the months ahead.
Last week's announcement that the Bank will be splashing out another 50 billion bounds ($79 billion) in asset purchases raised the total monetary stimulus since the program started in March 2009 to 325 billion pounds.
The hope is that by increasing the amount of money in the financial system, the purchases, known as quantitative easing or QE, will loosen credit for businesses and raise asset prices. Quantitative easing can be inflationary, but analysts say the bank has room to act.
Howard Archer, chief European economist at IHS Global Insight, said inflation could fall to 2 percent by the end of the year.
"We believe the improving inflation backdrop will give scope to the Bank of England to provide further stimulus to the economy," said Archer, who is predicting another 50 billion pounds stimulus in May.
Meanwhile, James Knightley, analyst at ING Bank, said inflation could drop to 1 percent by year-end.
"Inflation expectations tend to follow actual inflation and, given that the CPI appears to be heading sharply lower, we expect inflation expectations to do likewise," he said.
"This should further limit the risk of above-target inflation becoming entrenched, with workers unlikely, and unable given rising unemployment, to push for larger pay rises."
Wage increases have remained moderate despite high inflation, rising just 2 percent per year in the latest survey.
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