It’s a term we’ve all heard before, but how many of us really know what inflation means and how it affects our money?

Here we explain what inflation is, what causes it and the impact it can have on your spending powers.

What is inflation?

Most definitions for inflation will say something along the lines of the decline of purchasing power of a currency over time. In other words, inflation is the steady and sustained increase in the prices of the goods and services we buy. So far, so simple, but what does this actually mean and how does it happen?

A simple way to understand what inflation really means is to compare the price of an everyday item today to its price last year. So for example, a loaf of white bread that cost £1 this time last year might have risen in price to £1.02, which effectively means it has an inflation rate of 2%. Of course, inflation doesn’t only impact food prices, but the cost of everything we buy, from the price of a train ticket to a new t-shirt.

What causes inflation?

So what causes prices to rise? There are a huge number of reasons for inflation, and it can seem a little complicated, as many of these reasons are interlinked, but broadly speaking, inflation can occur when:

  • Business costs rise – known in the economic world as ‘Cost push’ inflation, this is where the cost of doing business goes up and this increase is passed on to the consumer. The cause of the rise in costs could be for a wide array of reasons, including:

    • Raw materials have become more expensive – If an item has become less readily available, or the country the item is being exported from is becoming more developed, they may charge more for their materials.

    • Workers demanding more money for their work – This can happen if a group of employees has organised themselves to demand higher wages, or where there is more demand for certain roles than there are people to fill them. We are currently seeing this in the UK with a shortage of HGV drivers, which has seen an increase in salary offers and packages to attract more people into the roles.

    • Increase in property prices – As the demand for appropriate working locations goes up, so do the prices businesses have to pay to get them.

  • There is greater demand for goods and services than there is supply – also known as ‘Demand’ inflation, as the demand for a certain item or service goes up, so does the price, as the amount of that item or service that is available is limited. Governments are able to stimulate this situation by offering tax breaks or reducing the amount of tax you pay, which means people have more disposable income and can inject more money into the economy, but as people have more money to spend, prices will also tend to increase, creating demand inflation.

  • The exchange rate changes – Much of the UK economy is based on imports and exports of goods to other countries, so when the pound weakens against other currencies, we will have to spend more to buy the same things as before.

  • More money is created electronically – When the economy is in need of support, as it was during the pandemic, the Bank of England can pump money into it via a process known as quantitative easing. This essentially involves creating new money electronically which is then used to purchase government bonds. This pushes up the price of bonds, which in turn means that the bond yield, or ‘interest rate’ that holders of these bonds get, goes down. Lower interest rates on bonds affect rates on loans for businesses, which become cheaper. This helps boost spending and pushes up inflation.

Is inflation a bad thing?

The type of low-level inflation we generally experience in the UK is not a problem in itself and as long as all areas of life keep up with inflation, such as wages, there is little issue. The reality is however, not all areas of life do keep up with inflation, and as a result, if prices rise, but wages don’t, people will have to sacrifice their way of living to accommodate their new budget.

With that said, the Bank of England is tasked with keeping inflation at a target rate of 2%, which is deemed to be a manageable level.

Sticking to this target aims to prevent the type of hyperinflation that we have historically seen in places like 1920s Germany, Zimbabwe in 2008, or Venezuela which started in earnest in 2016 and is still ongoing. These instances of hyperinflation have seen inflation rates of incomprehensible percentages, for example, Zimbabwe saw an annual inflation rate of 89.7 sextillion (89,700,000,000,000,000,000,000%) which essentially meant that prices were doubling every 24.7 hours. With our inflation rate in the UK sitting around 2%, and the highest recorded rate being 24.2% in 1975, fortunately, we’ve never been close to experiencing these levels of hyperinflation.

How is inflation monitored and controlled?

The Bank of England is the UK’s central bank which essentially means that it is in charge of managing the UK’s currency and monetary policies. It also oversees the commercial banking system.

As the UK’s central bank, it’s the Bank of England’s role to continually track inflation and try to maintain an inflation rate of around 2%. They can help to control inflation rates by changing the base rate (also known as Bank Rate), which is the most important interest rate in the UK, as it is the rate they pay to all commercial banks that hold money with them, and therefore the rates that those banks charge people or pay on their savings. Currently, the base rate is at 0.1%.

If the Bank of England increases the base rate, which then increases interest rates across the financial market, it will make saving a more attractive option and help slow down spending. If it lowers the base rate, the opposite happens, making spending a better option, and people will be more likely to take out loans and mortgages at this time as borrowing costs are lower.

While the Bank of England helps to control inflation, it’s the Office for National Statistics that actively monitors the inflation rate. To do this, it gathers prices of a set list of generic items which are meant to represent a range of items that any consumer may frequently buy. The list changes every year to align with changes in consumer taste. An example of this could be the inclusion of a new type of food such as quinoa if there has been a trend in people buying it across the country.

It is a statistic that is tracked by a number of different measures which include:

  • Consumer Price Index (CPI) – This measure of inflation tracks a list of items that represent the average shopping basket of goods and services in the UK and how their prices change over time. It is regularly updated to reflect the public’s changing preferences and shopping habits.
  • Retail Price Index (RPI) – The Retail Prices Index also tracks a basket of goods and services, but includes mortgage interest payments too, whereas CPI does not.

What does the current inflation rate mean?

The inflation rate has been steadily rising since the beginning of this year, although it saw a surprise dip in July, falling from 2.5% to 2%. Compared to last year our spending has increased for obvious reasons: with the easing of lockdown regulations, we are all spending more money as we are allowed to venture out for meals, drinks and social events after a long time indoors.

This difference in spending is therefore causing the inflation rate to rise, but what this means in the grand scheme of things will not be understood for another few months, once the full impact of measures taken by the government to stimulate the economy can be seen.

How might rising inflation affect my savings and investments?


When inflation rises sharply, interest rates will usually rise to dampen spending. If you have savings, this is good news for you, as higher interest rates will usually mean better returns.

However, if the inflation rate is higher than the interest you’re earning on your savings, then your savings could be worth less this time next year.

Rachel Springall, finance expert at financial website said: “Despite the fall in inflation, which is measured by the Consumer Price Index (CPI), our research has found that no savings account or ISA can currently match or beat the inflation rate of 2.0%. As well as this, the predicted rate of inflation is expected to reach 3.3%, which means many savers will likely struggle to find any savings accounts that will be able to keep up with the rate of inflation over the coming months.

“There has been a notable uplift to market-leading savings rates on offer since last month across various types of accounts and terms, which is positive to see. However, inflation is eating its way into savers’ hard-earned cash and with the expectation for it to rise, its eroding power will not be easing any time soon. Savers would be wise to not let this deter them from finding a more attractive rate, as deals are improving, and they may miss out on a market-leading rate if they become apathetic.”

A key area where high inflation can really affect people is through the erosion of the value of pension savings. While a lot of people’s savings are transitory, as they are often saving for a big purchase or life event, pension funds are a lifetime investment, and if a large proportion of your retirement savings is sitting in cash earning below-inflation interest rates, you could struggle to make ends meet when you retire. A key way to stay on top of whether your pension fund is beating inflation is to monitor the investment performance of your funds, and if they aren’t meeting the returns you would like, it may be worth exploring other investment options. For more information on this, have a look at our article Where is my pension invested?


The impact that inflation has on your investments will depend on the type of assets, such as bonds, stocks and shares or property you have. There are certain investments that tend to beat inflation rates, with the main one being property, although of course past performance should not be relied on as an indicator of what will happen in the future. The government reported general property price increases of 10.2% in the year to March 2021, which beat the March inflation rate of 1% by a whopping 9.2%.

Obviously buying a property as an investment is not a possibility for everyone because of the huge deposit needed to get started, so other investment opportunities people look to protect their savings from inflation are the likes of stocks and shares which can provide better returns than deposit accounts, although you must be prepared to accept the risk that you could get back less than you put in. Shares can potentially protect investors from inflation as the companies you invest in are often able to increase their prices in response to higher costs, which means they can then in theory grow at the same rate or higher than inflation. This won’t always be the case, however, and if you’re not sure where to invest, or whether investing is right for you, it’s a good idea to seek professional financial advice.

You can find a local financial advisor on VouchedFor or Unbiased, or for more information, check out our guide on How to find the right financial advisor for you. VouchedFor are currently offering Rest Less members a Free Financial Health Check with a local well rated financial advisor. There’s no obligation but once you’ve had your check, the advisor will discuss the potential for an ongoing relationship if you think it might be useful to you.

How might inflation affect my mortgage or loans?

Rising inflation usually leads to rising interest rates, which if you are looking to get a loan or a mortgage means you could end up shelling out a lot more for your property or loan in the long term.

If you already have a mortgage or a loan and are on a fixed rate, then it’s unlikely you will be affected by inflation, but when the time comes to remortgage if inflation rates haven’t gone down, you may struggle to find an attractive interest rate.

The people who could be hardest hit by rising inflation are those whose fixed interest period has ended on their mortgage and have moved onto a standard variable rate, or those with a tracker mortgage, which tracks movements in the Bank of England base rate. Both of these are likely to end up with higher interest rates to pay when inflation rises. If you are on your lender’s standard variable rate, you will usually be free to remortgage and should be able to find a much cheaper deal. Learn more in our guide Four good reasons to remortgage right now.

Do you factor inflation into your personal finances? Or have you got any inflation-beating tips? If so, we’d be interested in hearing from you. You can join the money conversation on the Rest Less community forum, or leave a comment below.


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