Rising inflation: How it's hurting your finances

Spiralling commodity prices plus the government's recent VAT hike means our money is losing value faster than it has done for years. Inflation is once again a real concern.

The consumer prices index is currently 4.4%, over double the Bank of England's 2% target, and Bank of England governor Mervyn King warns that it could reach 5% in coming months.

The worry now is that this is just the beginning of an upward trend; while it's far too early to know if inflation will hit the dizzying heights of the 1970s, when it reached 25% in 1975 and averaged 13% a year across the decade, it does seem as though the only way is up.

So what does this all mean for you?


Everyday expenses like food and fuel will be the areas where we feel the impact of inflation most. Shopping website mysupermarket.co.uk's inflation tracker follows a number of typical supermarket items: its total for March 2011 was £481.70 compared with £459.23 in March 2010.

Thanks to fuel duty and oil price rises, petrol prices are also hitting record highs of an average of £1.32 (reaching £1.40 a litre in some places) in March 2011. Rail fares are also on the up, rising by 6.2% in January. Likewise, the average energy bill is now £1,132, according to uSwitch, compared with £1,104 a year ago.

So what can you do?

To cut motoring costs, go to petrolprices.com to find the cheapest petrol pumps in your area. For cheaper energy bills, switch to an online tariff and pay by direct debit, or check if another provider can offer you a better deal. And to combat rising food costs, buy own-brand items, and compare prices according to price per weight rather than the labelled price.


While prices are moving steadily up, savings rates are going nowhere. Low interest rates also magnify the impact of rising prices, as our money will buy even less over time. For example, £50,000 in a savings account that pays 1% interest would have grown to £52,551 after five years. That's £2,551 worth of interest, right? Unfortunately, due to inflation, its value will have dropped in real terms to £42,372, according to AEGON (based on 4.4% inflation).

National Savings & Investment index-linked certificates used to be one way of protecting your savings against inflation, because the rate they paid was linked to the retail prices index (the RPI includes mortgage payments, unlike CPI); however, they were taken off general sale in July last year due to oversubscription fears and it's not known when they will reappear. 

So if you're looking to keep pace with inflation, you need to find a cash ISA paying 4.4%, or a non-ISA savings account that pays even more (to take account of tax). A basic-rate taxpayer needs to earn 5.51% gross and a higher-rate taxpayer 7.34% gross, according to Moneynet.

Read our round-ups of the best cash ISA and best savings rates


To fix or not to fix? That's the question on many mortgage holders' lips. A few years ago, it looked as though interest rates might shoot for the stars. So homeowners decided to fix – only to see the base rate, which mortgages track, plummeting to 0.5% and tracker mortgages charging incredibly low interest rates.

At the moment, it seems that jitters about mortgage rate hikes are causing more homeowners to remortgage and search for fixed deals. The increased demand means the best deals aren't around for long and fixed rates are being pushed up. But David Hollingworth, spokesperson for London & Country, says that variable rates are still attractive, even with a base rate rise.

Read: Inflation: What it means for your mortgage

"It's impossible to predict what will happen, but even if the base rate goes up to 1%, some borrowers will think: 'I can still get a cheaper rate on a variable rate or tracker'. Others like the certainty of knowing what they're paying each month," he adds.

Hollingworth suggests that first-time buyers consider fixing as they haven't yet had to budget for mortgage payments. But if you want to remortgage, you should assess whether you could realistically afford a potential rise in your mortgage payments. Offset mortgages are also worth considering, he says: instead of earning minimal interest on your savings, your savings will reduce the amount of interest paid on your mortgage.


Gilts (government bonds), and to a lesser degree corporate bonds, look particularly vulnerable, because they pay a fixed rate of income that buys less as inflation eats into it – although there are inflation-linked bonds that try to counter this. As far as investing in UK equities is concerned, companies that produce real things that people will buy regardless of price, like big food retailers, tobacco companies, utilities companies and pharmaceuticals, look the safest bests.

"These are all defensive industries which are best placed to perform in difficult economic times," says Patrick Connolly, spokesperson for AWD Chase De Vere.

Ultimately, you're not going to be able to beat inflation with your savings, but over the longer term there's potential for greater total returns that could outpace inflation.


Inflation hits pensions hardest when they are used to buy an annuity – or a regular income – in retirement. The vast majority of annuity holders buy level (unchanging) annuities, rather than escalating or index-linked annuities that increase each year. This is because a level annuity promises a greater yearly income to start with. However, that amount will never change; by contrast, index-linked annuities rise in line with inflation each year, while escalating annuities go up annually by a set amount.

Laith Khalaf, pensions analyst for Hargreaves Lansdown, points out: "A 65-year-old man with £100,000, for example, would be able to get a level annuity that pays out £6,500 a year, but if his annuity was inflation-linked the income would start at around £4,200."

For more read: How rising inflation can destroy your pension

Basically, the longer you expect to live, the more significant inflation risk becomes when you're choosing what type of annuity to go for. If you get a level annuity but then live for another 40 years, you're still going to receive the same income.

Having said that, Khalaf calculates that inflation would need to be over 5.2% for a significant period before an inflation-linked annuity pays for itself. He suggests an escalating annuity, halfway between level and index, as a safer option.

How is inflation worked out?

There are two measures of inflation: the consumer prices index (CPI) is the official measure, while the retail prices index (RPI) tends to be slightly higher – it's 5.5% at the moment – because it includes mortgage payments. Both indices look at the costs of a basket of approximately 700 goods and services that typify consumer spending habits; an average figure is then calculated by getting 110,000 price quotations each month.

The Office for National Statistics' personal inflation calculator shows your own rate of inflation. Go to statistics.gov.uk/pic/ and fill in your details.

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