How rising inflation impacts your money

6 min read 15 Feb 23

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High levels of inflation, rising interest rates and the impact of the cost of living crisis, means many people are having to choose between today’s necessities and planning for their future. News reports regularly highlight that income from employment or pensions isn’t keeping up with inflation, but what exactly is inflation and why is it so important?

Put simply, inflation is the term used to describe rising prices. The Office for National Statistics (ONS) measures inflation by looking at the cost of a standard ‘basket’ of everyday goods and services, such as bread or a bus ticket, but also includes larger purchases, such as a car or a holiday. The change in the cost of the items in the basket is used to calculate a standard rate of inflation.

The higher the rate of inflation, the less your money will buy. For example, if the ONS observes the cost of a pint of milk rising from £1 to £1.10, then a 10p increase shows an inflation rate of 10%:

When you bear in mind that the current UK inflation rate is 10.1%* (as at February 2023), you can see how even small increases in the costs of everyday essentials could add up over time, raising your cost of living and reducing the buying power of your hard-earned money.

* Source: Bank of England

Inflation is impacted by a number of factors within the economy, but increases typically occur when the cost of producing goods and services go up. It can also be caused by a surge in demand for a product or service, when consumers are willing to pay a higher price for something that may be hard to come by.

During the current climate, it makes sense that the increase in the cost of energy that is impacting us all at a household level is affecting businesses too – when a company’s production costs go up, due to higher energy bills or the increased cost of raw materials due to supply chain issues, these extra costs may be passed onto consumers, by increasing the price that we have to pay.

Although the Bank of England predict that the rate of inflation is likely to have peaked in the UK, the current rate is well above the 2% inflation target set by the Government.

One way in which the Bank of England aims to tackle the rate of inflation is to adjust interest rates. By raising the Bank of England base rate, the cost of borrowing money typically increases. When people have less disposable income, due to the high cost of loans, mortgages or energy, they tend to spend less on non-essential items. When people are buying less, the demand for goods and services goes down which, over time, can lead to prices going down too.

The Bank of England’s aim is to keep inflation low and stable, but not too low. If consumers expect prices to fall further they may put off spending money, which in turn could damage the economy. For example, if a company isn’t making enough money due to lower sales, they may have to reduce their workforce, resulting in job losses – and when people are out of work, they obviously have less money to spend. 

If you’re worried about the rising rate of inflation and the impact it may have on your ability to make ends meet, you’re not alone. An ONS report shows that due to the rising cost of everyday items such as pasta and bread, around half of all adults in Great Britain are buying less when food shopping, with lower-income households hardest hit by rising food costs.

You might not notice an extra 10p or 20p here and there on everyday purchases. But when you add up all these small increases, you’ve probably noticed that your money isn’t going as far as it used to. But what impact might high inflation have on your money over the long term?

Although high rates of inflation affect us in the here and now, it can also have an impact on what you can buy with your money in the future, as the value of your money is eroded over time.

The graph below shows that if we assume 3% inflation each year, although it’s currently much higher, £10,000 today could be worth just £4,776 in 25 years. Less than half its original ‘value’. Inflation can have a serious impact on your money, so it’s important to think about this when budgeting in the short and long term.

Inflation erodes the value of your money over time
  • The example shows an inflation rate of 3%, but please note that inflation can be more or less than this.
  • The example also assumes that the sum has not grown over time, as no interest has been added.

Understanding the impact of inflation can help manage your day-to-day finances and may help you plan for future expenses. The ONS has a useful calculator to show how increases in the cost of living for a range of categories, including groceries, housing, transport and leisure, have affected your household costs. You can access their calculator on the ONS website.

If you’re worried about the impact of inflation on your money, we recommend that you get financial advice to help you consider your options. If you don’t already have an adviser and would like to speak to someone, you can find a financial adviser that's right for you.

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