Inflation Explained: How Rising Prices Affect Your Money in the UK

Inflation is the rate at which prices rise over time. A little inflation is normal in a healthy economy, but even modest inflation steadily reduces what your money can buy. Understanding it helps you plan savings, pensions and big purchases more realistically.

This guide explains how inflation is measured in the UK and how it compounds over time. To see the effect on your own figures, use the inflation calculator.

What is inflation?

Inflation measures how much the price of a typical basket of goods and services has changed over a year. If inflation is 3%, something that cost £100 a year ago costs about £103 today.

The flip side is that the same £100 buys less. That's why inflation is often described as eroding the purchasing power of money.

How inflation is measured in the UK

The Office for National Statistics (ONS) publishes several measures each month. They track the prices of hundreds of items, from food and fuel to rent and broadband.

RPI is generally higher than CPI because of the way it's calculated, and it's no longer an official national statistic.

The Bank of England's 2% target

The government sets the Bank of England a target of keeping CPI inflation at 2%. The Bank's Monetary Policy Committee mainly uses interest rates to do this: raising rates tends to cool spending and bring inflation down, while cutting rates supports spending when inflation is low.

How inflation compounds

Inflation compounds in the same way as interest. Each year's price rise is applied to the already-higher prices from the year before. Over long periods, that adds up.

At 3% a year:

• After 10 years, £100 of shopping costs about £134.
• After 20 years, it costs about £181.
• £100 kept as cash would buy only about £74 of today's shopping after 10 years.

A useful shortcut is the rule of 72: divide 72 by the inflation rate to estimate how many years it takes for prices to double. At 3%, prices double in about 24 years. At 6%, it's about 12. You can test different rates in the inflation calculator.

Why inflation matters for your money

Savings

If your savings earn less interest than the rate of inflation, their real value falls, even though the balance goes up. This is called a negative real return. Comparing savings rates with inflation helps you see whether your money is keeping pace. Our savings interest calculator can help.

Pay

If your pay rise is smaller than inflation, your real income has fallen. A 3% pay rise when inflation is 5% feels like a raise but buys less than before.

Pensions and retirement

Inflation matters most over long periods. A pension pot that sounds large today may buy much less in 25 years. That's why our pension fund calculator shows results in today's money. The State Pension rises each year under the triple lock, which helps protect it against inflation.

Debts

Inflation can work in your favour on fixed-rate debts. If your mortgage payment is fixed while wages and prices rise, the payment becomes relatively smaller over time.

Ways to protect your money from inflation

1. Shop around for savings rates and move money to accounts that pay more.
2. Use tax-free accounts such as ISAs, so more of your return is kept.
3. Consider investing for long-term goals. Over long periods, shares have historically grown faster than inflation, though they can fall in value and returns aren't guaranteed.
4. Fix costs where it makes sense, such as energy tariffs or mortgage rates.
5. Review your budget regularly as prices change.

Historical inflation

To see what money from the past would be worth today using official price data, the Bank of England's inflation calculator goes back hundreds of years. Our calculator is designed for looking ahead using an average rate you choose.

Inflation and interest rates

Inflation and interest rates are closely linked. When inflation is high, the Bank of England usually raises its Bank Rate to make borrowing more expensive and saving more attractive, which tends to slow spending and bring price rises down. When inflation is low or the economy is weak, it may cut rates. These decisions feed through to mortgage rates, loan rates and savings rates, so inflation affects your finances indirectly as well as through prices.