Inflation goes down to 3 per cent but it's not good news for Britain

Britain was today braced for a dangerous bout of deflation after living costs barely increased last month.

Official figures show the retail prices index rate of inflation fell from 0.9 per cent in December to 0.1 per cent in January.

It was dragged down by cheaper mortgage repayments, falling energy prices and steep discounts on the high street.

The fall stoked fears that Britain is heading for a period of deflation as the recession worsens.

The Government's preferred measure of inflation, the consumer prices index, which strips out housing costs, also fell from 3.1 per cent to three per cent having peaked at 5.2 per cent in September.

Experts warned that deflation could be disastrous for the economy. A long period of price falls would see consumers put off spending in the hope of buying goods more cheaply in future, leading to crumbling profits and soaring unemployment.

Philip Shaw, chief economist at banking group Investec, said: "We still think it likely that inflation will drop into negative territory for a while this year."

A sustained period of deflation crippled the Japanese economy in the Nineties but has not been seen in this country since the Second World War.

Since October, the Bank of England has cut interest rates from five per cent to one per cent - a record 315-year low - as it battles to stop inflation falling too far. It is now considering "quantitative easing", a modern form of printing money, to boost spending, curtail the recession, and prevent deflation.

The Government has set a target of two per cent inflation. This has not been undershot since September 2007 when inflation dipped to a still safe level of 1.8 per cent.

Inflation peaked above five per cent last year as rising food and energy costs sent prices up for British consumers. However, the oil price has since fallen from $147 (£104) a barrel to below $40 a barrel, leading to cheaper petrol prices and falling household energy bills.

The Government's decision to cut VAT from 17.5 per cent to 15 per cent has also taken the sting out of inflation by lowering prices on the high street.

The prospect of deflation is particularly worrying given that the Bank of England warned last week that the UK economy would contract by up to six per cent by the middle of this year and continue to decline into 2011.