This article was last updated 30/01/2023.

What is inflation?

Inflation is the steady increase in the prices of the things we buy and the subsequent decrease in the purchasing power of currency over time. This increase in prices is often quoted as a percentage. Conversely, deflation describes a general decline in prices and an increase in the purchasing power of a currency.

What is the current rate of inflation in the UK?

The rate of inflation in the UK is reviewed every month and is quoted as a percentage rate increase or decrease over the previous 12 month period. The quickest way to check the latest rate of inflation is to use the inflation tool on the ONS website.

At the time of writing, the rate of inflation in the UK (as measured by the official rate of CPIH) stood at 9.2% in the 12 months to December 2023.

To put the rate of inflation in context:

An inflation rate of 1% means that it would cost £1,010 today to buy something that cost £1,000 12 months ago.
An inflation rate of 3% means that it would cost £1,030 today to buy something that cost £1,000 12 months ago.
An inflation rate of 6% means that it would cost £1,060 today to buy something that cost £1,000 12 months ago.
An inflation rate of 9% means that it would cost £1,090 today to buy something that cost £1,000 12 months ago.
An inflation rate of 12% means that it would cost £1,120 today to buy something that cost £1,000 12 months ago.

How has inflation changed in the UK over time?

We are currently experiencing a period of incredibly high inflation. Back in 1991, inflation was similar at over 9% each year, however the trend since around 1993 has been around 2.5%.

UK Inflation since January 1989 - Consumer prices index with housing (CPIH).

How is inflation calculated?

In the UK, there are two main measures of inflation, the Retail Prices Index (RPI) and the Consumer Prices Index (CPI). In both measures, the prices of a pre-agreed basket of goods are tracked over time to see whether the price goes up or down. Historically, the main difference (alongside the calculation basis) has been that RPI included the cost of housing such as mortgage interest payments, whereas CPI has not. However, RPI has been criticised as it is heavily influenced by increasing house prices and is therefore not a fair indication of the price of general goods and tends to be higher than CPI.

More recently, a revised version of CPI has been used, called CPIH, which includes housing costs in the form of ‘rental equivalence’ - which is essentially how much a householder would pay to rent a property.

Why does inflation matter?

The underlying rates of inflation (and the measures used) are very important because many costs and payments are linked to them. For example, rail fares, student loans, road tax, duty on alcohol and tobacco, some annuities and defined benefit pension schemes, amongst many other items, are typically linked to RPI, which means they will increase at the highest rate.

Conversely, the government links state pensions, benefits and other forms of state aid to CPI as this often increases at the lowest rate.

There is a growing push to replace RPI and CPI with CPIH as the universal measure when used in the above scenarios, which would affect people in different ways. For example, those that smoke or are paying back student loans would see their expenses fall, whereas those receiving income from an annuity or defined benefits pension would see their income fall.

How does inflation affect my salary?

As prices increase, the purchasing power of the money you earn will fall over time. It’s easy to say that it’s only a few pounds a month, however, the effect on your purchasing power will compound over time. For example, we can all remember when decent family homes were available for £100,000, a new car was £10,000 and petrol was less than £1 per litre. The Bank of England has a useful calculator on its website that allows you to look back and see how the value of money has fallen over time. To illustrate with approximate figures:

Something that cost £10,000 in 1950 would cost £260,000 in 2022.
Something that cost £10,000 in 1960 would cost £176,000 in 2022.
Something that cost £10,000 in 1970 would cost £120,000 in 2022.
Something that cost £10,000 in 1980 would cost £37,000 in 2022.
Something that cost £10,000 in 1990 would cost £21,000 in 2022.
Something that cost £10,000 in 2000 would cost £16,000 in 2022.
Something that cost £10,000 in 2010 would cost £13,000 in 2022.
Something that cost £10,000 in 2020 would cost £11,000 in 2022.

Ensuring your salary keeps pace with inflation is crucial to maintain your buying power over time. You can use our Salary Inflation Calculator to work out what pay rise you need to ensure your salary tracks inflation.

Salary Inflation Calculator

How does inflation affect my cash, savings and investments?

Looking at the table above, it’s clear that putting cash in a shoebox under your bed is an easy way to lose money. If you put £10,000 away in the year 2000, it’s value would have eroded dramatically by now due to inflation and you would need over £16,000 to buy the same goods and services as it could have bought back then.

Furthermore, simple savings accounts with banks and building societies also often pay below-inflation interest rates, which means your purchasing power will still be eroded over time. According to the Bank of England, the average annual rate of inflation since the year 2000 has been 2.4%. This means that you will need to have achieved an interest rate of 2.4% every year for your savings just to break even and to still be worth the same.

Conclusion.

It’s clear that inflation affects us all and knowing the different between RPI, CPI and CPIH can really help your financial position over the long term. What are your experiences of inflation over time? Is there one thing that you’ve encountered that made you realise the change in prices? Please let us know in the comments below.

This article offers information about financial planning and should not be taken as personal advice.

What is inflation and how does it affect my money?