What does inflation mean?​

The first thing that tends to muddy the water when we talk about inflation is that not everyone measures it the same way. After all, not every price is going up by the same amount at the same time. Depending on which kinds of goods and services you're keeping an eye on, you'll come away with a different idea of how sharply overall prices are going up.

There's an organisation called the Office for National Statistics that keeps track of inflation (along with a lot of other things). To do this, they pick out a 'basket' of more than 700 things that they reckon a typical buyer will regularly splash out money on. That includes everything from basic essentials like food and transportation to holidays and health costs. By tracking the changes of that make-believe basket from year to year, they work out how much more we're having to pay for them then before. Because it deals with the day-to-day costs of typical people, this way of measuring inflation's called the Consumer Prices Index (CPI).

Here's where things get a little more complicated. The CPI isn't the only system that's used to work out the overall rate of inflation. The CPIH statistic, for example, includes housing costs for homeowners in its basket as well. There's also another system called the Retail Prices Index (RPI), which uses different goods and methods to come up with its calculations. RPI used to be the main figure people referred to when they talked about inflation, but it's basically been replaced by the CPI now.

When the rate of inflation hit 10.1% in July 2022, it was treated as a pretty big deal—and if you crunch the actual numbers, it's not difficult to see why. With inflation at 10%, it means you're paying £11 for every tenner you would have spent last year, assuming you're buying the same amount of the same things. That tenner you have in your pocket is therefore worth less than it was the year before, since you can buy less with it. Assume that you're spending £1,000 instead of £10, and suddenly your costs are going up by £100 from one year to the next.

Because inflation's measured as a percentage, the bigger the purchase the more the price rockets up. In fact, it can still get pretty scary when you work out what all those price bumps on smaller purchases add up to, as well. That's why governments set themselves a target for inflation, aiming to stop it from spiralling out of control. With the inflation target set at 2%, it's then up to the Bank of England to hit the mark. Why 2% instead of 0% or even less? Well, strange as it sounds, having an economy's inflation rate fall too low can actually be a little unhealthy. A negative inflation rate, for instance, would see prices generally dropping over time. A situation like that can actually end up with people slowing down their spending, because they expect costs to be lower if they wait. That makes sense for your personal wallet, but if enough people do it then businesses get into trouble and people can start losing their jobs. Generally, having a low but steady inflation rate is considered healthier for everyone, because it keeps the money flowing through the economy and helps everyone plan out their finances better.

As for what the Bank of England's got to do with this, they use something called the Bank Rate to influence inflation. Again, this can get a little complicated, but the basic idea is that the Bank Rate is the interest the Bank of England pays to banks and building societies that hold accounts with it. When the Bank Rate goes up, the interest those banks and building societies offer to the rest of us tends to go up too. This encourages people to save more and spend or borrow less (because the interest rates rise on loans as well as savings). In turn, this sucks money out of circulation and generally drags inflation down. Dropping the Bank Rate, on the other hand, encourages people to spend and borrow more instead of saving, which can push inflation rates higher.

Obviously, prices rocketing up are a worry for basically everyone. Almost 1 in 6 people who were asked in a survey said that they'd been leaning on credit cards more than usual just to get by while the inflation rate's been high. Over 1 in 5 say they've had to borrow more in a month than they had the year before. When the Bank of England raises its interest rate to try and control inflation, all of that everyday borrowing gets more expensive. The same goes for people paying off mortgages. Higher interest rates mean higher repayments. Close to half the people surveyed said they weren't going to be able to save any money at all in the upcoming 12 months because of skyrocketing prices. With energy costs ramping up by massive amounts, 2 in 5 said they were going to have serious problems paying their gas and electricity bills.

Looking at the biggest forces pushing prices up throughout 2022, some of the biggest factors are housing and utilities (water and energy), food and drink (non-alcoholic) and transport. Those costs alone are causing over 50% of the rise in the CPIH. For most of us, these are things we really can't afford to cut back on. In budgeting terms, that means a lot of those costs sit in the "essentials" category, which you'd normally want to put about half your household income toward. You can learn more about building a better budget in our article, "Tips to Beat the Rising Cost of Living", which also covers important tips on dealing with debts.

Guide: Beat The Cost of Living

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