The further fall in the level of annual inflation in January to 5.2 per cent will give the Minister for Finance, Mr McCreevy, additional ammunition in his defence of his Budgetary policy to EU finance ministers on Monday.

Consumer prices fell by 0.8 per cent last month, reflecting the fall in oil prices and the impact of the January sales.

On an EU harmonised measure, inflation was down 1 per cent last month and up 3.9 per cent in the 12 months since January 2000. This is no longer the highest rate in the EU Dutch inflation is running at 4.5 per cent on the EU measure in January from 2.9 per cent in December.

According to Dr Dan McLaughlin, chief economist at ABN Amro, the average EU harmonised rate in January is likely to accelerate again to 2.8 per cent or 2.9 per cent, narrowing the gap between the EU and Ireland to only 1 percentage point. "This is hardly a cause for concern given the growth differential. Ireland will grow at 10 per cent in 2000 against under 2.75 per cent in the euro zone."

However, there is some debate about the future direction of inflation. Most economists are agreed that it will continue to fall back over the year and will average between 4.25 per cent and 4.75 per cent. However, European Commissioner Mr Pedro Solbes has insisted that the underlying trend is upwards. And some analysts here have warned that the rate could accelerate again in February as higher general charges and increases in VHI premiums feed into the figures.

Mr Alan McQuaid of Bloxham Stockbrokers and Mr Austin Hughes of IIB Bank have both predicted that inflation will rise to 5.5 per cent in February. Mr Jim Power, director of investment strategy at Friends First, pointed out that oil prices were also moving up again following the election of Mr Ariel Sharon as Israeli president. But IBEC director of economic affairs, Mr Brian Geoghegan, said the figures underlined that the European Commission's criticism of the recent Budget was "excessive and alarmist". Government chief whip Mr Seamus Brennan welcomed the figures. "The Government will continue to monitor inflationary developments closely and in co-operation with the social partners, will seek to ensure that the positive trends of the last two months are sustained," he said.

But Labour party finance spokesman Mr Derek McDowell criticised the level of inflation. "The Government may find some comfort in the figures but the reality is that our inflation rate is still double the EU average."

The Small Firms' Association was also less than bullish. SFA director Mr Pat Delaney cautioned that Irish inflation is still too high relative to the rest of the euro zone.

IIB's Mr Hughes also pointed to the domestic factors which were becoming more important in determining the cost of living. "The Minister cannot take the same blunt approach continuing to cut taxes and boost spending sharply regardless of economic conditions. In this respect the Commission is not attacking Ireland's past record, it is worrying about future prospects if budget policy continues in the same direction at the same speed. It might be better for all concerned if the criticism were properly understood and Ireland's key economic relationship was strengthened rather than strained."

Over the month of January the price of clothing and footwear fell 11.6 per cent and durable household goods fell by 3.4 per cent. Falling oil prices were reflected in a drop of 2.1 per cent in transport costs and 1.8 per cent in fuel and light.

The 1 per cent reduction in VAT had a less marked impact with many signs that it was not passed on by many retailers.