Inflation is the reason a pound buys less than it used to. Prices rarely move all at once, and they almost never move in a straight line, but over any decade you care to pick the general direction in the UK has been up. If you keep savings, earn a wage or pay a mortgage, inflation is quietly redrawing your sums every month. This guide explains how it works, how it is measured, what pushes it up and down, and what it means in practice for money sitting in a savings account.
What inflation is
Inflation is the rate at which the general level of prices rises over time. It is usually given as a percentage change compared with the same month a year earlier. If annual inflation is 3%, a basket of shopping that cost £100 last year costs about £103 now. The important word is general. Coffee might jump while televisions fall; inflation is the average of all those movements, weighted by how much households actually spend on each thing.
The flip side of rising prices is falling purchasing power. Your £20 note does not change, but what it fetches does. At a steady 3% a year, £10,000 kept in cash would buy only about £7,441 worth of today’s goods after ten years. At 2% it would still buy about £8,203. That gap of nearly £800 is the cost of a single percentage point, compounded.
How inflation is measured: the ONS basket
The Office for National Statistics tracks a notional shopping basket of goods and services that represents what UK households buy. Price collectors record thousands of prices each month, both in shops and online, and the ONS combines them into an index. The annual percentage change in that index is the inflation rate you see in the headlines.
The basket is reviewed every year so it keeps up with how people really spend. For 2026 the ONS added 27 items and took out 19, leaving 760. Houmous, alcohol-free beer, pet grooming, motorhomes and dashboard cameras went in; sheets of wrapping paper came out. Each item carries a weight based on household spending, so a rise in energy or rent moves the index far more than a rise in the price of a board game.
That weighting is also why your own inflation rate can differ from the official one. A renter who drives a lot and heats a draughty house will feel energy and fuel spikes harder than the average. A homeowner with a fixed-rate mortgage and no car may feel them much less.
CPI, CPIH and RPI: the differences
The UK publishes several measures, and they tell slightly different stories. Knowing which is which helps when a pay offer, a pension increase or a savings product quotes one of them.
| Measure | What it covers | Where you meet it |
|---|---|---|
| CPI (Consumer Prices Index) | Household spending on goods and services, using international methods | The Bank of England’s 2% target; most benefits and the State Pension uprating |
| CPIH | CPI plus owner occupiers’ housing costs and council tax | The ONS’s preferred lead measure |
| RPI (Retail Prices Index) | An older index that includes mortgage interest payments and uses a different formula | Some long-running contracts, older index-linked gilts and some regulated prices |
RPI tends to run higher than CPI, partly because of the way it averages individual prices. In 2013 it lost its status as a National Statistic, and the ONS now says plainly that it is a poor measure of inflation and discourages its use. It survives because so many long-term contracts were written around it.
What causes inflation: demand, costs and money supply
Economists group the causes into a few families, and in real life they usually overlap. Demand-pull inflation happens when people and businesses want to buy more than the economy can produce, so sellers can raise prices without losing customers. Cost-push inflation starts at the other end: when energy, raw materials or wages get dearer, firms pass at least some of those costs on. The 2022 surge in UK prices was largely cost-push, driven by the jump in gas and electricity prices after Russia’s invasion of Ukraine, and annual CPI inflation peaked at 11.1% in October that year.
Money supply matters too. If the amount of money in an economy grows much faster than the goods and services it can buy, prices tend to rise to soak up the difference. Expectations close the loop. If workers expect prices to climb they ask for bigger pay rises, and if firms expect costs to climb they raise prices early. That is why central banks care so much about keeping expectations anchored, not just about this month’s figure.
Price rises also travel. A failed harvest or a spike in shipping costs shows up first in wholesale markets, then in what manufacturers charge, and only months later on the shelf. By the time a rise reaches your receipt, the original cause may already be fading.
The Bank of England’s 2% target and interest rates
The government sets the Bank of England an inflation target of 2% a year, measured by CPI. The Bank’s Monetary Policy Committee, which has nine members, meets eight times a year to decide Bank Rate, the interest rate it pays on reserves held by commercial banks. If inflation lands more than one percentage point either side of target, the Governor has to write an open letter to the Chancellor explaining why and what the Bank plans to do about it.
Raising Bank Rate makes borrowing dearer and saving more rewarding, which cools spending and, with a lag of a year or more, takes pressure off prices. Cutting it does the opposite. The target is 2% rather than zero because a little inflation gives the economy room to adjust, and because falling prices can be harder to escape: people delay purchases, debts get heavier in real terms and firms cut back. At the time of writing in October 2026, CPI inflation was 3.1% for the year to August and Bank Rate stood at 3.75%.
Bank Rate is not the rate on your savings account. It is a wholesale price between the Bank and the banks. What your bank pays you depends on how keen it is to attract deposits, and the gap between the two can be wide.
Real interest rates: why your rate against inflation is what matters
The interest rate printed on a savings account is the nominal rate. What you actually gain or lose in spending power is the real rate, which is roughly the nominal rate minus inflation. A 4.5% account with inflation at 3.1% earns a real return of about 1.4%. A 1.5% account in the same year loses about 1.6% of its buying power, even though the balance has gone up.
Here is what that looks like on £10,000 left untouched for a year, with inflation at 3.1%:
| Savings rate | Balance after a year | Worth in today’s money | Real change |
|---|---|---|---|
| 1.5% | £10,150 | £9,845 | about £155 lost |
| 3.1% | £10,310 | £10,000 | standing still |
| 4.5% | £10,450 | £10,136 | about £136 gained |
Tax can change the picture. Most people can earn some interest tax-free through the Personal Savings Allowance, which is £1,000 a year for basic-rate taxpayers, £500 for higher-rate taxpayers and nothing for additional-rate taxpayers. Take a higher-rate taxpayer with £25,000 earning 4.5%. The £1,125 of interest is £625 over the allowance, so £250 goes in tax and the effective rate falls to 3.5%. Against 3.1% inflation, that real return is now barely above zero. Money held in an ISA is not taxed on its interest, which is why the wrapper matters more for larger balances and higher earners.
How inflation affects savings, pensions and debt
Cash savings are the most exposed, because their value is fixed in pounds. Over a few months the effect is small; over decades it is huge. A useful shortcut is the rule of 70: divide 70 by the inflation rate to estimate how many years it takes for prices to double, which is also how long it takes cash to lose half its buying power. At 3% that is a little over 23 years.
Pensions are a mixed picture. The State Pension rises each year under the triple lock, by the highest of CPI inflation, average earnings growth or 2.5%. Many older defined benefit pensions are also linked to an index, often with a cap. Defined contribution pots have no automatic protection; whether they keep pace depends on what they are invested in and what you draw from them.
Debt works the other way round. A fixed-rate loan or mortgage gets lighter in real terms when inflation is high, because the repayments stay the same while wages and prices rise. That help is often short-lived. High inflation usually brings higher interest rates, so anyone on a variable rate or coming to the end of a fixed deal can find the cost of borrowing rising faster than the benefit.
Inflation in history: from debasement to the 1970s
Inflation long predates paper money. Rulers who were short of cash could quietly reduce the precious metal in their coins and spend the difference; the coin kept its face value, but traders soon worked out what it was really worth and raised their prices. England’s Great Debasement under Henry VIII in the 1540s is the best-known British example, and it pushed prices sharply higher.
The modern peak came in the 1970s. Oil price shocks, rapid wage rises and loose policy combined, and annual RPI inflation reached 26.9% in August 1975. Prices roughly doubled within about five years. That decade is the reason the UK eventually gave the Bank of England operational independence to set interest rates in 1997, with a clear inflation target to aim at.
Options savers use to soften inflation
There is no single product that beats inflation every year, and this guide does not recommend any particular provider. What savers commonly do is work through a short list of levers and choose the ones that fit their own circumstances.
The first lever is the rate itself. Easy-access accounts, notice accounts and fixed-term bonds pay different rates, and loyalty rarely pays; an account opened years ago may now pay far less than new ones. The second is the tax wrapper. The ISA allowance is £20,000 for the 2026 to 2027 tax year, and interest earned inside it is tax-free. The third is protection. The Financial Services Compensation Scheme covers eligible deposits up to £120,000 per person, per banking licence, so it is worth knowing which brands share a licence before spreading money around.
Beyond cash, some savers hold investments for money they will not need for many years. Over long periods shares have historically outpaced inflation more often than cash, but they can fall sharply and stay down for a long time, so they are not a home for an emergency fund or for money needed soon. Index-linked government bonds track inflation directly but can still lose value if bought and sold at the wrong time. If you are unsure, free and impartial guidance is available from the government-backed MoneyHelper service, and regulated financial advisers can give personal advice for a fee.
Reading inflation headlines without panicking
Headlines tend to treat each monthly figure as a verdict. A few habits make them easier to read. First, falling inflation does not mean falling prices. If inflation drops from 4% to 3%, prices are still rising, just more slowly. Second, one month is noise; the trend over several months is the signal. Third, check which measure is being quoted, because a story using RPI will usually sound worse than one using CPI. Fourth, remember that your own basket is not the national basket. A rise driven by air fares means little if you are not flying this year.
Finally, watch the gap rather than the number. For a saver, 4% inflation with a 5% savings rate is a better year than 2% inflation with a 0.5% rate. The real rate is the figure that decides whether your money is growing or shrinking.
Checklist: inflation-proof your savings review
- Note the latest CPI figure from the ONS and the date it covers.
- List every savings account, its current rate and whether that rate is fixed or variable.
- Work out the real rate on each: interest rate minus CPI.
- Check how much interest you expect this tax year against your Personal Savings Allowance.
- Use any unused ISA allowance before 5 April if interest will exceed your allowance.
- Confirm each balance sits within the FSCS limit for its banking licence.
- Keep three to six months of essential costs in easy access, and only then consider fixing the rest.
- Diary a date to repeat the review in six months, or sooner if a fixed term ends.
FAQ
Is inflation good or bad for me?
It depends on what you hold and what you owe. Moderate, stable inflation is normal and is what the Bank of England aims for. People with large cash savings on low rates lose out, while borrowers on fixed rates gain in real terms. High or unpredictable inflation is bad for almost everyone, because it makes it hard to plan, erodes fixed incomes and usually brings higher interest rates for anyone who needs to borrow.
Why don’t prices go back down when inflation falls?
Because inflation measures the speed of price rises, not the level of prices. When it falls from 10% to 3%, prices are still climbing, only more slowly than before. Outright falling prices across the whole economy, called deflation, are rare in the UK and are generally seen as a warning sign rather than good news, because they tend to come with weak spending and rising unemployment.
What is the difference between CPI and CPIH?
CPIH is CPI with the costs of owning and living in your own home added, using an estimate of the rent a homeowner would pay for an equivalent property, plus council tax. The ONS treats it as its most comprehensive measure. CPI remains the one the Bank of England targets and the one most headlines quote, so both are worth knowing.
Does inflation affect money in a current account?
Yes, in exactly the same way as any other cash. A current account paying no interest loses buying power at the full rate of inflation. Keeping enough in it to cover bills and a buffer makes sense, but larger sums left there for months or years are shrinking in real terms, which is why many people move surplus cash into an account that pays interest.
Who decides the 2% target?
The Chancellor of the Exchequer sets the target each year in a remit letter to the Bank of England. The Bank then decides how to hit it, mainly by setting Bank Rate. That split, with the government choosing the goal and the Bank choosing the tools, has been in place since the Bank gained operational independence in 1997.
