As inflation reaches 9.4% – what is it and how will it impact your savings?

The Office for National Statistics is tasked with estimating the UK inflation rate.

20 July 2022

Inflation hit a new 40-year high when it pushed to 9.4% in June, squeezing family budgets up and down the country.

New research from Charles Stanley suggests that people are taking steps to cut costs, with 30% cutting back on everyday perks, nearly one in three cutting luxury items and 23% reducing what they spend on holidays.

But an even larger proportion do not understand what inflation is doing to them. The research found that 41% either admitted to not knowing, or gave a wrong answer when asked what impact inflation would have on their savings.

One in 10 thought that inflation would increase the value of their savings, which is wrong. Another one in 10 believed that it would have no impact, while 22% of people said they did not know what the impact of inflation would be on their savings.

UK historic inflation rate
(PA Graphics)

So what is inflation, and how will it impact your savings and your mortgage?

– What is inflation?

At its heart it is a way of checking how quickly prices are rising for households across the UK.

It is an average across many categories, so if food prices rise, that could still be offset by drops in, say, the price of petrol.

– How is inflation measured?

The Office for National Statistics (ONS) is tasked with estimating the UK inflation rate.

It has a basket of goods and services that it tracks. It might be helpful to think of this as a massive shopping basket with what the ONS thinks that people in the UK buy.

It includes around 730 items, anything from dating agency fees to condoms, wild bird seed to petrol, and crumpets to pet food.

What is in the basket changes every year – with some additions and some removals – because what people buy changes.

For 2022 antibacterial surface wipes were added, along with meat-free sausages and other items.

Price rises in past 12 months
(PA Graphics)

Each month the ONS sends its researchers into the field to gather 180,000 different prices for 730 goods or services.

They then take an average of the increase or decrease from a year ago – and this is the inflation rate.

– What does inflation mean for mortgages?

The biggest change for mortgage holders comes with the knock-on effects from high inflation.

The Bank of England tries to keep inflation at 2% and when inflation rises above that point the Bank will try to bring it back down.

One of the main ways to do this is by increasing the Bank’s interest base rate. This rate is generally used to calculate the interest that you pay on your mortgage.

So when inflation goes up, the interest you pay on your mortgage is likely to go up.

– What does inflation mean for savings?

The impact of inflation on savings is much more direct. If you have £1,000 in in cash under your mattress and inflation is at 10%, that money will only be able to buy around £909 worth of goods and services a year later.

Pay growth v inflation
(PA Graphics)

It can be profound at times like today when inflation is out of control, but even in more normal times inflation can slowly eat away at savings.

One bonus for savers is that interest rates will go up. These do not just increase the amount borrowers have to pay on their mortgage, it also means that banks will pay savers more interest on their savings.

– What does inflation mean for wages?

Like with savings, wages will be rapidly eroded, with the buying power of your salary a year ago reduced significantly.

If inflation is at 10%, a worker making £20,000 after tax will discover that their pay only goes as far as around £18,200 went a year ago.

In times of high inflation workers will often demand more frequent and higher pay rises from their employers to make sure they can continue to live the same way as before.

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