A quick guide to inflation

Back in August, the UK's annual inflation rate plummeted to a five-year low of 0.2%, driving down the cost of living. The highly popular Eat Out to Help Out scheme was mostly behind one of the biggest inflation drops in recent years as it pushed down prices in restaurants and cafés. But what exactly is inflation, and what does it mean for your money?

Inflation is a measure of the rate at which the prices of goods and services change over time, an indicator of a country's well-being because it affects what consumers can buy with their money. Consequently, governments track inflation obsessively and try to keep it low.

The rate of inflation is published each month by the Office for National Statistics and is presented as a percentage increase or decrease.

A rise in inflation means your money won't stretch as far as it once did. When inflation goes up, so do the prices of goods. And if wages don't keep up with inflation, your purchasing power is diminished even further, and your standard of living may fall.

What Does the Drop of 0.2% Mean For Me?

In the short term, this is good news for you and your wallet or purse, for the simple reason that prices won't go up. Filling up your car costs less than it did a year ago, and you may even see
your energy bills falling.

When the Bank of England sets the base rate, which influences what banks charge borrowers and pays savers in interest on deposits, inflation is one of the key factors it considers. If the UK's central bank thinks that inflation is likely to be below a set percentage, it may cut interest rates to lower borrowing costs. In March, it cut the base rate to a historic low of 0.1%.

However, very low inflation can risk deflation when prices decrease over time. This may sound good, but it is actually bad news for the economy. During times of deflation, there are more goods and services available and not enough money to purchase them. So demand slows down.

Companies drop prices to sell their products, but they cut costs if they end up with surplus inventory. This can mean staff being laid off. Hence, the government's increased efforts to get people to go back to work, which should increase demand for products and services.

November 2020