Fears over the looming danger of deflation were stoked by the Governor of the Bank of England yesterday as plunging fuel costs triggered another sharp retreat in price pressures last month.

Mervyn King warned the Chancellor that the outlook for the economy had worsened in recent weeks, and highlighted a substantial risk that inflation will drop below 1 per cent next year.

Earlier, official figures showed that headline inflation on the consumer price index (CPI) dropped sharply again last month, to 4.1percent. This was down from 4.5 per cent in October, and from a record 5.2 per cent in September, to the lowest since June.

The Governor's warning came in his third explanatory letter to Alistair Darling since June setting out why inflation remains more than double the Bank's 2 per cent target.

Mr King is required to write a letter every third month while inflation exceeds its target by more than a full percentage point, and to explain what the Bank is doing to return it to target.

He had no difficulty in explaining in his latest letter how inflation would be brought down, however. With recession sending inflation plunging, he told the Chancellor that he expected it to return to target in the first half of next year, and then “move materially below it later in the year”.

The Governor added to worries that inflationary pressures could fall so sharply that the Bank will instead soon find itself fighting deflation - sustained falls in overall prices. “It is possible that I will not need to write a further open letter to you in three months' time,” he wrote. “Indeed, it is quite possible that I will next need to write to you to explain why inflation has deviated by more than one percentage point below the target during 2009.”

Most economists expect that Britain will experience some form of deflation, with consistent falls in prices across the economy on both the CPI and the retail price index during much of next year.

The waning danger from inflation and the growing risk of a deep recession has already seen the Bank order drastic cuts in interest rates to an historic low of only 2 per cent. Mr King's comments and the latest falls in inflation reinforced expectations of still deeper rate cuts next year.

Fuel was the driving force behind today's latest sharp reversal of inflationary pressure, recording its sharpest monthly price decline for at least a decade.

On the CPI figures, overall fuel prices plummeted by 8.3 per cent last month leaving them 3.6 per cent below their levels of a year earlier. This was the first time that the annual rate of fuel inflation has been negative since last August. Average petrol prices fell by 9.3p a litre between October and November, to 95.2p a litre.

While the Government's temporary cut in value-added tax (VAT) is soon set to wipe another 1.3 points off inflation rates if passed on in full by retailers, Mr King also made clear that the Bank would set aside both this, and subsequent upward effects on inflation when VAT returns to its past level, when taking future interest rate decisions.

Other factors limit yesterday's drop in inflation, meanwhile. Upward pressure came from food prices, with the cost of fruit rising by 10.8 per cent from a year earlier - twice the pace of increase reported in October. There were widespread increases in the cost of fruit such as bananas, pears, strawberries and oranges. This was blamed on the recent slide in the pound, which drives up import bills. Most fruit sold in Britain is imported.

Overall food price inflation remained in double digits, at an annual rate of 11.7 per cent, although it eased from an August peak of 14.5 per cent.

People are paying nearly 18 per cent more for staple goods such as bread, milk and minced beef this month than they did a year ago, according to figures from mysupermarket.co.uk, the price comparison website.

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