Inflation explained – why is it so high and how could it affect you?
With inflation at its highest level in 41 years and energy prices skyrocketing, the cost of living crisis has dominated headlines since inflation began to creep up from historic lows in mid-2021.
Following such an extended period of price rises, you may be concerned about your household finances and long-term plans.
What is inflation?
Inflation measures how the average price of goods and services changes annually, and is the main driver of the cost of living crisis.
Each month, the Office for National Statistics (ONS) monitors the price of 700 goods and services to determine how much an average household’s shopping basket changed in the preceding 12 months. This provides the Consumer Prices Index (CPI), which is one of the key ways we measure inflation.
The Bank of England (BoE) is tasked by the government to keep inflation to 2%.
A small level of inflation each year is good for the economy. However, when inflation rises above the 2% target, it can put more pressure on consumer finances and lead to problems in the economy.
Inflation could soon start to fall
In response to rising inflation, the BoE has raised the base interest rate several times throughout 2022, most recently to 3.5% on 15 December 2022. This is expected to encourage more people to save, reducing demand for goods and services, so slowing the pace of price increases.
However, experts predict that inflation will remain high for some time, not returning to the 2% target until 2024. Interest rates are expected to continue to rise into 2023, which could lead to higher mortgage rates and monthly repayments for borrowers.
Your experience of inflation may be different
The ONS makes certain assumptions when calculating UK inflation, such as that the average household allocates 9.8% of their monthly budget to personal travel costs like owning a car. If you do not own a car, your personal inflation rate might be lower than average.
Using an online calculator to understand your personal inflation rate will make it easier to focus on the facts that affect you rather than noisy, often sensationalist, headlines.
A combination of world events raised inflation
Several events in recent years have led to the sharp rise in inflation.
The Covid pandemic
During Covid lockdowns many workplaces closed, so normal manufacturing stopped temporarily. This led to a shortage of products. So, when the lockdowns ended, and we resumed our day-to-day lives, demand outstripped supply and prices rose.
The war in Ukraine
Food prices – specifically animal feed, fertiliser and vegetable oil – have risen directly because of the war, which had a knock-on effect on the price of everyday products such as sugar.
Energy prices have also soared to the highest level in 10 years as many European countries rely on Russia for imported natural gas.
The weakened pound reduces buying power
The value of the pound against the dollar has slowly dropped throughout 2022 from $1.335 on 4 January to $1.146 on 1 November.
GET IN TOUCH
If you’re worried about the rising cost of living and would like to discuss ways to protect your finances from the effects of inflation, we’re here to help. Please get in touch to arrange a time to chat.