Consumers saw little change in shop prices in January following the 2.5% VAT increase, according to new figures.
The impact of the increase was all but non-existent because of the unusually high number of post-Christmas discounts and promotions, the British Retail Consortium (BRC) said.
Overall shop price inflation increased to 2.5% in January from 2.1% in December driven by an increase in food inflation from 4% to 4.6%, while non-food inflation increased marginally to 1.3% from 1.1% in December, the BRC-Nielsen Shop Price Index shows.
The "subdued" rise in non-food inflation offered clear evidence that retailers had absorbed the vast proportion of the VAT increase into their profit margins to the benefit of consumers, the BRC said.
BRC director general Stephen Robertson said: "The VAT rise had little effect on shop prices in January. Poor Christmas trading left retailers with stock to shift. The impact of the increase was almost entirely lost among the unusually high number of post-Christmas discounts and promotions.
"The rate of inflation for non-food goods - mainly the ones subject to VAT - was only 0.2 percentage points higher after the VAT rise than before, showing retailers generally took the hit on behalf of customers.
"But, with a range of other cost pressures also squeezing margins, retailers will struggle to go on absorbing it.
"Rising commodity prices continue to push up food inflation, now to its highest for a year and a half. Even so, shop prices are still rising more slowly than other wider measures of inflation that include petrol, utilities and services."
Mike Watkins, senior manager of retailer services at Nielsen, said: "Inflationary pressures continue, in particular in food, which is why the promotional discounts given by food retailers still remain at an all-time high.
"With over two thirds of shoppers looking to make further savings on household bills to compensate for rising utility bills, travel costs and now the rise in VAT, and faced with a squeeze on disposable income this year, we can expect shoppers to manage their household budgets tightly during 2011."