Consumer Prices Index inflation could fall to 3% by the end of Q1 2012 as the impact of the VAT hike and high oil prices falls away.
The Bank of England said in its latest quarterly Inflation Report released today that CPI inflation - currently at 5% - could fall by as much as 200 basis points as quickly as the end of Q1 next year.
In the report the Bank said: "The impact of the rise in VAT is likely to drop out by the end of 2012 Q1.
"And, unless oil prices increase significantly again, the direct contribution of petrol prices to CPI inflation should also fall markedly by early 2012.
"Together, the direct contribution of VAT and petrol prices to CPI is likely to decrease by around 1.5 to two percentage points between late 2011 and the end of 2012 Q1."
CPI dipped in October, according to inflation figures out earlier this week, falling marginally from 5.2% last month.
Elsewhere the Bank of England, headed by governor Mervyn King (pictured), warned the "prospects for the UK economy have worsened" following events in Europe.
It said: "Global demand slowed and concerns about the solvency of several euro-area governments intensified, increasing strains in banking and some sovereign funding markets.
"Household and business confidence fell, both at home and abroad. These factors, along with the fiscal consolidation and squeeze on households' real incomes, are likely to weigh heavily on UK growth in the near term."
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