News reports about inflation can feel abstract until you are standing at the till or opening an energy bill. Behind the headlines sits a fairly simple idea with very practical consequences for every household budget in the UK.
V5 Solutions has put together this explainer to answer the questions people ask most often about inflation: how it is measured, why it affects some families more than others and what you can do to soften the impact.
What Is Inflation?
Inflation measures how quickly the general level of prices is rising over time. It is usually expressed as a percentage change compared with the same month in the previous year. While inflation is positive, each pound you hold buys slightly less than before. Low, steady inflation is barely noticeable from one month to the next. High inflation can put household finances under real strain in a short space of time.
How Is Inflation Measured in the UK?
The Office for National Statistics (ONS) publishes the main measures every month. The best known is the Consumer Prices Index, or CPI. To calculate it, statisticians track the prices of a "basket" of several hundred goods and services that a typical household buys, covering food, clothing, energy, transport, leisure and more. The contents of the basket are reviewed regularly to keep pace with changing spending habits.
The government sets the Bank of England a target of keeping CPI inflation at 2%. When inflation runs well above that level, the Bank's Monetary Policy Committee may raise interest rates to cool demand and bring price growth back under control.
You may also come across CPIH, which adds certain housing costs faced by homeowners, and RPI, an older measure that is still used in some calculations, such as the interest on some student loans.
Why Does Inflation Hit Some Households Harder?
CPI is an average, and very few households match the average exactly. Your personal inflation rate depends on what you spend your money on. For example:
- Lower-income households tend to spend a larger share of their income on food and energy, so increases in those prices affect them more.
- People in rural areas often travel further by car and may rely on heating oil, which can swing sharply in price.
- Tenants may face rent increases at the same time as other costs are going up.
- Anyone with a variable-rate mortgage or loan can see repayments climb if interest rates rise.
What Are Real Wages?
Real wages compare how fast pay is growing with how fast prices are growing. Imagine your salary goes up by 3% while prices go up by 5%. In that case your real wage has fallen by roughly 2%. You have more pounds, but each one buys less, so your standard of living has slipped.
Savings work in the same way. When the interest on your savings account is lower than the rate of inflation, the spending power of that money shrinks over time, even though the balance grows.
How Can You Protect Your Budget From Rising Prices?
Rebuild your budget around current prices
A budget written a year ago may no longer reflect reality. Work through recent statements and update each category. Our guide to working out the main figures in your budget explains where to begin.
Plan for bills that do not arrive monthly
Rising prices make annual costs such as insurance and car maintenance harder to absorb in one go. Saving towards them gradually helps, as covered in our article on building an annual bills calendar.
Review contracts before and after you sign
Some phone, broadband and pay TV contracts include price rises during the minimum term, which may be linked to inflation. Read the terms before agreeing to a deal, and when the minimum term ends, compare what else is available rather than rolling over automatically.
Claim everything you are entitled to
Many people miss out on benefits they qualify for, often because they assume they earn too much. The free benefits calculators listed on GOV.UK can tell you in a few minutes whether you might be eligible for support you are not receiving.
When Should You Ask for Help?
If inflation has pushed your outgoings above your income, talk to someone sooner rather than later. This article is general information, not financial advice. For help with your own situation, National Debtline and StepChange provide free, impartial debt advice, and Citizens Advice can help with benefits, housing and energy problems. For ideas on preparing for tougher economic times, read our guide to protecting household finances in a downturn.
