The fall in inflation in December was mainly due to lower motoring costs (petrol prices) and lower food prices. These brought goods price inflation down to 2.7% (from 3.2% in November), while service sector inflation rose from 2.8% to 2.9%.
Underlying these trends is the recent strength of sterling. The service sector is largely insulated from overseas competition and imports make up only a tiny fraction of its total costs. Hence, the rise in sterling's value last year has little impact on prices. Instead, the steady strengthening of consumer demand is leading to a gradual creep up in service sector inflation.
Goods prices, however, are impacted by the currency. The rise in sterling makes imports cheaper, reducing domestic manufacturers' costs, but also making it necessary for them to restrain price increases if they are to compete with overseas companies. There are also direct benefits from a strong currency. Last year's 16% gain in sterling has gone a long way to offset the rise in oil prices on international markets. Hence, the good news on petrol prices in December. It is also making food imports cheaper too.
If the general election is held on May 1st, which is still most commentators' expectation, the last published inflation data will be for March. This is likely to show an underlying rate of around 2.8%, below the current rate, but above the chancellor's target range. The opposition will present this as a failure, though in the light of the UK's inflation history of the last 30 years, it will actually be quite an achievement.