Inflation fell to three per cent in January, the Office for National Statistics (ONS) revealed today.

The Consumer Prices Index (CPI) fell from the December of level of three per cent to 3.1 per cent – compared to recent highs of 5.2 per cent in September.

The Retail Prices Index (RPI) dropped to 0.1 per cent – from 0.9 per cent in December – the lowest RPI inflation rate since March 1960 – as the prospect of deflation begins to stalk the economy.

The Bank of England’s target is to hold CPI at two per cent – and interest rates are already at one per cent as the central bank predicts further falls to the cost of living.

In its Inflation Report last week, the Bank predicted CPI is likely to drop under one per cent this year as the UK faces recession – and stay drifting at that level until 2012.

The ONS reported, while prices fell in the January sales, the cuts were less than in previous years, providing upward pressure on inflation – while falling oil and transport costs pushed the index down.

The stat crunchers reported the average price of petrol fell by 2.9p per litre between December 2008 and January to 86.3p, compared with a rise of 1.3p last year.

Howard Archer, chief UK economist at IHS Global Insight, explained the fall in inflation was less than expected – due to heavy sales in December meaning there were fewer discounts come January – but RPI is likely to turn negative next month.

“Will the smaller-than-expected drop in CPI in January deter the Bank of England from taking further near-term action to boost the economy? No,” he said.

“It will not fundamentally alter the bank’s view that consumer price inflation is likely to substantially undershoot its two per cent target level over the medium tern due to the extreme weakness of the economy.

“We still expect the Bank of England to cut interest rates further in March, most likely by a further 50 basis points which will take them down to a new record low of just 0.50 per cent.”

He explained members of the monetary policy committee were sympathetic to savers, but rate cuts were coming – to as low as 0.25 per cent in the second quarter of the year – for the sake of the economy.

Last week, Mervyn King, governor of the Bank of England, made it clear that as interest rates fall lower and lower the effect of further cuts on the economy were reduced – as banks cannot pass them on.

He also said starting to push more cash into the economy through quantitative did not need interest rates to drop to close to zero per cent.