How does inflation affect me?

This month’s news that UK inflation is below the level predicted is positive for people everywhere. When combined with recent evidence of wage growth, it means your money’s going further than it may have done in the recent past. In short, it means people in the UK can afford to enjoy a higher standard of living – something that we must all welcome… But what determines the rate of inflation, why is it important and what does the future have in store?

What is inflation?

The most basic definition of inflation is increasing prices. Undoubtedly, prices are always increasing. But what matters is that they don’t increase so fast they outpace wages and make the cost of living unaffordable for ordinary people, leading to a personal finance crisis.

How is inflation measured?

In the UK, the main measure of inflation is the Consumer Prices Index, which tracks prices and records and reports any changes. In February, the Index revealed an inflation rate of just 1.8% in January, compared with wage growth of around 3% on average. Importantly, this figure is below the 2% inflation rate target set by the Bank of England.

What causes inflation?

There are two main types of inflation. These are cost-push inflation and demand-pull inflation, both of which can have big consequences for our personal finances. Cost-push inflation is where prices increase because of higher costs of materials, labour, transport and storage, among other things… Meanwhile, demand-pull inflation happens when supply is limited, and people are willing to pay more in order to get what they want; therefore, pushing up the price for everyone. A classic example of demand-pull inflation is the upward trend in house prices over many years.

Why is the latest inflation figure so low?

Financial analysts have cited lower petrol, diesel and gas prices as a key factor for the currently lower-than-expected rate of inflation. Last Christmas also saw a significant slowdown in the retail sector compared with previous years, with people choosing not to spend as much.

What happens when inflation gets out of control?

History shows us the devastating effects of out-of-control inflation. In Germany during the 1920s, hyperinflation saw people moving wheelbarrows of cash around, just to shop for basic household items. Today we see a similar problem in Venezuela, where people rush to spend their wages before prices increase again. But don’t worry, hyperinflation is a rare consequence of gross economic mismanagement by governments.

How do we control inflation?

The main way of tackling inflation is by preventing people spending as much money. This is done by raising interest rates, making the cost of borrowing more expensive. However, this tactic is no silver bullet. Indeed, raising interest rates too much can cause businesses to go bankrupt, causing unemployment and an economic slowdown or even a recession. Raising interest rates can also lead to people being unable to pay their mortgages.

What will happen next?

David Mills from Compass said:

“Undoubtedly, the latest inflation figures are good short-term news for everyone.
“Unfortunately, the big economic unknown for the UK is still what happens with Brexit.
“If the pound loses value after we leave the EU, then this will make the goods we import, including oil, more expensive; therefore, pushing up the rate of inflation, perhaps significantly.
“Right now, all we can do is hope that these positive signs don’t turn out to be the calm before the storm.”

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