We heard this week that the easing of coronavirus lockdown measures coincided with a slight increase in the UK inflation rate (now around 0.6%) 📈
Interestingly, although inflation is slowly on the rise, this figure is well under the Bank of England target of 2%. With that in mind, we thought it was worth taking a refresher on some basics, and why a little inflation can be a good thing 👌
Inflation explained simply 🤝
Inflation is the term for a process where the cost of goods and services increases gradually over time. And it's especially bad news for savers...
Inflation means that money will slowly lose 'purchasing power' (i.e. what can actually be bought with a specific amount of money). This is why the pesky 'cost of living' keeps increasing over time during periods of inflation!
The cruel thing about inflation is the fact that it can be considered a universal tax, because it targets normal folk just a mercilessly as it does the rich.
How is inflation measured? 📐
Inflation is measured by looking at any price changes across thousands of the most commonly purchased items. And this list is constantly being refreshed to reflect changing tastes and provide a cross-section of society.
The Office for National Statistics (ONS) produces three inflation metrics:
- the Consumer Prices Index (CPI)
- the CPI including owner-occupiers' housing costs (CPIH)
- the Retail Prices Index (RPI)
How does inflation affect me? 🙋♀️
We already mentioned something referred to as the cost of living, and how inflation causes this to rise over time.
The flip-side of this is that your wages need to keep up at the same rate, or your actual standard of living (aka, the amount of nice things you can buy with your money) will decrease in real terms 🎁
Is inflation good or bad? 😇 😈
The thing about inflation is, if you have any money, stored anywhere, then this relates to you! So it's important that we all understand the nuances.
The most positive aspect of the current news on the UK inflation rate, is that a lower rate of inflation means savers don't need to work quite as hard to ensure their nest-egg maintains its value over time 🐣
Sounds good, right?
Well, yes, it's undeniably better, but the flip side is that your savings are still losing spending-power over time... now just at a slower pace!
Who benefits from inflation? 🔎
Although inflation is bad for savers, it can actually benefit borrowers.
People with a fixed-rate mortgage will effectively have their debt reduced during periods where inflation rises unexpectedly.
Inflation can also act as something of a release valve for the economy. It allows workers salaries to be indirectly harmonised according to demand in the job market, as employers respond to changes in the real cost of living.
How to fight inflation 👊
As with most matters finance, there is no single, correct answer here.
There are many different approaches, but the aim is always to ensure any money you have is earning a return that's greater than the rate of inflation. Without this, your money will be worth less over time ⏳
Finding a savings account that does this is an awesome start! However, even if you do find an account with a rate of interest that's actually greater than inflation, it is very likely that your returns will still be relatively marginal.
This is why savers with any significant amount tucked away will often look to an ISA, or an investment in stocks and bonds, as possible ways to potentially increase their returns over the long-term 🌱
Always remember that your capital is at risk if you choose to invest.Download Plum