What does the UK’s soaring inflation rate mean?
As inflation rises to its highest rate in a decade, we look at the implications for consumers, savers and interest rates
Last modified on Wed 15 Dec 2021 05.03 EST
The headline rate of inflation in the UK has risen to 5.1% – its highest rate in a decade. The speed of increase has taken forecasters by surprise – last month the Bank of England said it expected inflation to peak at 5%, but not until April next year.
What is inflation?
It is the measure of how much prices are rising and falling and is tracked by several different indices. The main measure used by economists is the consumer prices index (CPI), which records the cost of a basket of 700 items including food, transport and entertainment. The headline rate refers to how much those prices have gone up over a year. The Bank is tasked with keeping annual inflation at 2% but it has been above that for six of the last seven months and is now much higher.
Why is October’s figure so high?
The Office for National Statistics, which publishes the figures, said higher prices for transport, food, clothing and footwear had driven up the rate.
Transport costs were the biggest contributor. Petrol prices rose by 5.1% month on month to reach a record high – the ONS said a 7.2p a litre increase between October and November was the biggest monthly increase it had recorded since it started keeping the figures in 1990. Second-hand car prices have also increased as supply chain difficulties have continued to hold up the number of new cars going on to the market.
Clothing and footwear prices were up over the month. The ONS said this was usual at this time of year, but last year prices were low, so the annual rise is larger than normal.
What does this mean for me?
Moderate inflation is not a bad thing – people will be more likely to spend their cash if they think it will buy less in future. But high inflation has consequences. Most obviously, if you are on fixed pay then your money will not go as far each month.
“This is the kind of inflation that is felt by almost everyone, although clearly those on low and fixed incomes such as pensioners, face the toughest struggle to keep their standard of living within their budget,” says Becky O’Connor, head of pensions and savings at Interactive Investor.
“Budgeting will need to be turbo-charged for those with little disposable income left at the end of the month. It could push some people further into regular overdraft and credit card use, or result in some families being unable to pay their bills. People who have been relatively relaxed about the need to budget in the past may also need to consider belt-tightening.”
What if you are saving?
Rising inflation at a time when interest rates are at record lows is bad news – your money will not have the same buying power when you withdraw it as it did when you put it away. Put very simply, if you put away £100 last year, it would need to be worth £105.10 to have the same value in real terms. The best one-year account currently pays 1.39%, so in a year your savings would be worth £101.39.
Moving into higher-risk investments is a way to try to beat inflation but there is always the chance you could lose money, too. “Real interest rates for savers will remain resoundingly negative for the foreseeable future,” says Adrian Lowery of Bestinvest. “Investors are also seeing their returns eroded at the moment but equities and other investments provide the only reasonable expectation of maintaining the real value of one’s savings.”
If high levels of inflation stay for longer than anticipated, the Bank may raise interest rates, which would be good news for those with cash on deposit. However, it has so far resisted doing this, and when it announces its latest decision on Thursday few expect an increase.
“The Bank is caught between its two primary functions – controlling inflation and ensuring financial stability,” says Ed Monk, associate director at investment firm Fidelity International. “With inflation already so far above its 2% target, getting prices under control would appear a pressing priority. The problem is that there is clearly a concern that the economy is too weak to withstand any increase in borrowing costs.”
What if you are borrowing?
If you have a loan on a variable rate of interest, a rise in the Bank base rate would push up your repayments. Fortunately, many people have opted for fixed-rate mortgages, and costs will remain the same even if the Bank does act to curb inflation.
And inflation reduces the size of your debt in real terms. If it leads to a pay rise, then the sum you need to repay each month will be less of your income than when you first took on the loan.
What about student loans?
The rate of interest on student loans is linked to inflation, so a high rate sounds like bad news for many of those with university debts. The rate that matters is the RPI (retail prices index), which hit 7.1% in August, and students who have started university from 2012 are supposed to pay an interest rate of RPI plus 3.
The good news for them is that the rate is calculated based on March’s figure, so there is time for it to fall. Also the rate is monitored against commercial personal loan rates, and altered accordingly. It has been capped below RPI plus 3, and the government may step in if RPI is still running high.
What about pay?
Most workplaces do not have to raise pay in line with inflation but it is often used in negotiations. Employers, who in some sectors are already battling with staff shortages, may have to increase wages to attract and retain workers who need to meet higher living costs. The UK’s national living wage – the minimum that employers can pay workers – is set to rise by 6.6% in April. The real living wage, which is paid to 300,000 UK workers, was increased last month.
And pensions and other benefits?
A number of benefits are linked to inflation, including the state pension. The government suspended the pensions “triple lock” this year, and in April pension payments will rise in line with September’s CPI of 3.1%. If inflation stays at its current level, those relying on the state pension for all of their spending will see their incomes eroded and could struggle with some of the costs they need to meet.
Elements of universal credit and other benefits will go up by the same percentage next April. Some private pensions offer payments linked to inflation, so payouts should increase.
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