The real impact of inflation

Inflation and the fast pace at which it’s rising is dominating headlines at the moment. And it’s not surprising. With inflation at a 40-year high (1), it’s natural that people are concerned and keen to understand how it will affect day-to-day lives.

What is inflation?

The Office for National Statistics (ONS) calculates price rises – inflation – as the change of prices of a ‘basket’ of every-day goods and services, such as the cost of energy, clothing, transport, food, and drink, among many others. There are many different baskets, but the most commonly quoted is the Consumer Prices Index (CPI).

The current rate of inflation in the UK is the highest it has been for decades. Since the early 90s, inflation has rarely moved above 4%, spending much of the past 30 years at around 2%. There has been an upward trend over the past two years – CPI has increased nearly every month since mid-2020, and currently sits at 10.1% (2).

Why is this bad?

As the saying goes, you can have too much of a good thing and the same is true for inflation. If inflation continues to be elevated for a prolonged period, it can lead to something known as ‘hyperinflation.’ This is as a result of the expectation that prices will continue to rise, which actually fuels inflation.

More worryingly though, economists have recently predicted that the UK could be heading for a period of ‘stagflation.’ This is when the economy sees slow growth, high unemployment, and rising prices (3).

And how could it affect you?

There are a number of ways that high inflation could impact you and some are more obvious than others. Results from our ‘Inflation Watch Report’ (4) discovered that the majority of UK consumers (69.9%) identified the rising cost of gas and electricity as having the greatest effect on them and their family. However, there are other ways that inflation could impact you that you may not have considered.

The value of your money is diminished

Perhaps the most obvious effect of inflation is that it erodes the purchasing power of our money. With the prices of goods and services consistently increasing, it’s clear that money loses its value. And when the value of our money decreases whilst our incomes remain the same, our standard of living can reduce rapidly.

Your bank account may not be the best place for your money

There are two reasons why people tend to save less when inflation is high. First, as the cost of living increases, there is less spare cash to put away for a rainy day, and second, even if money is put into a savings account, it’s essentially losing value over time.

As we’ve already covered, during inflation the purchasing power of money is negatively impacted. However, many people still believe that a savings account is the best place for money at the moment. Our ‘Inflation Watch’ research found that only 1.6% of UK consumers thought that the biggest financial impact of inflation was on their savings. This is understandable with nearly two-thirds of respondents (59.3%) telling us that they either don’t know (31.9%) or are unsure (27.4%) how much interest their savings account is currently paying.

We believe good retirement planning involves making appropriate investments

When inflation is at its more usual lower level, the unfavourable impact it has on savings can easily be overlooked. In reality, the chances are that the price of all the goods we buy and services we consume today will be more expensive in the future.

This can sometimes be difficult to get your head around, after all in the future a pound is still a pound. Yet the amount you can buy with that pound is reduced and so the ‘real’ value of your money is eroded.

Investing in assets such as shares, bonds, property and commodities is seen as risky by many. But leaving your money in a bank account with a low interest rate exposed to high inflation could potentially be an even riskier alternative. In our view, good retirement planning involves investing for the long term in a range of investments appropriate to your level of risk.

Inflation could provide the nudge you need to review your retirement plans

Inflation could be damaging for your retirement plans. To be prepared for the potential impacts of inflation on your retirement, it’s generally considered best practice to start investing as early as possible and to invest more than you think you’ll need.

(1) https://www.bbc.co.uk/news/business-62562025, 17 August 2022

(2) What is inflation? | Bank of England, 17 July 2022.

(3) Cityam.com, 3 August 2022

(4) Inflation Watch Report, Schroders Personal Wealth – August 2022