Inflation, and its effect on the standard of living, is becoming a major concern for households and policymakers. From rising food prices to pay packets of diminished value, a rising cost of living affects everyone.

But what exactly is inflation, what causes it and how long is the current rate of inflation going to be in place?  

What’s inflation and what’s causing it? 

If you’ve been keeping a close eye on the news, and your weekly shop, you might have noticed that the price of things is going up: a litre of unleaded petrol is today almost 50 per cent more expensive than a year ago, household energy costs increased 54% in April 2022 alone, while even crisps and soft drinks are becoming more pricey. UK inflation is currently running at 9.1%, more than fives higher than the Bank of England's target of 2%.

So why are prices going up all of a sudden? 

The answer is something called inflation and it’s not just happening in the UK either – a whole host of countries across the world are experiencing what some people are calling an inflation ‘crisis’. 

There are a few different ways of measuring inflation, but one of the most common measures used in the UK is the Consumer Price Index (CPI), which looks at the changing prices of some of our favourite products.

Very simply, inflation happens when the costs of things increase. As an example, if a £1 jar of jam goes up by 5p, the price has inflated by 5%. Inflation isn’t always a bad thing, but when prices increase too much or keep rising for too long, it can present some problems. So, what’s really going on?  

Many countries around the world are struggling with inflation, and one of the biggest reasons for this is the pandemic.

When Covid-19 struck, countries around the world were forced into lockdowns: factories shut down, workplaces closed and many businesses stopped trading altogether. During this time, most governments stepped in to provide massive investments and support to keep people out of poverty and to keep the economy alive.

In the UK, the biggest source of support was the furlough scheme through which the government started paying many workers’ wages. 

Many households built up unexpected savings as a result of having fewer opportunities to spend when working from home and the shops being closed, for example. When restrictions started to lift, these savings poured out into the economy exactly as hoped. 

The problem is that with many countries around the world still facing strict Covid-19 regulations, lacking access to or uptake of vaccines or continuing to dip in and out of lockdowns, there just aren’t enough products to go around: there are fewer businesses working with fewer staff producing fewer items.

Despite all the money going around, businesses can’t quite keep up and prices are going up as a result. 

A more recent driver of inflation is Russia's ongoing conflict with Ukraine. This has led to higher commodity and energy prices, which means it's costing more to fill up our cars and heat our homes.

The UK is also facing the additional problem of Brexit disruption. Since the UK has left the EU, many businesses are finding it much more difficult to get things in and out of the country. 

What does inflation impact? 

Everything. As consumers all need to start paying more for day-to-day items, households will increasingly find their money is worth less. After all, if everybody has to pay more for the grocery shop, there’s less money to spend on other things.  

But inflation can have a particularly challenging effect on savers, homeowners and those already retired. If you’ve been saving for a long time, are paying off a mortgage or are drawing on a fixed pension pot, all of a sudden you can find yourself having to pay more with less.  

The last time inflation was this high was 40 years ago. While this occured before some of you were born, you may remember more recent events such as the 2008 global financial crisis. Back then, inflation reached just above 5%. As inflation rose and interest rates fell, savings accounts were no longer able to keep pace with the rising cost of living.   

One of the most common ways central banks and governments try to combat inflation is by changing interest rates – the amount of interest you will earn on your money when placed in a savings account.

If the interest rate goes up, people will save more and spend, making item shortages less acute and, in theory, bringing prices down. This will also impact things like mortgages though. Higher interest rates can mean the amount you will need to pay on a mortgage could increase. 

As with all financial questions, having sound, expert advice is paramount. If you aren’t sure, it’s better to get clear guidance rather than trying to guess what to do next. 

Inflation during the remainder of 2022 

So, the big question on everyone’s lips is: will the recent spate of interest rate rises effectively curb rising costs? 

While it's been good news for savers, homeowners who aren’t on a fixed-rate mortgage have seen their monthly mortgage payments rise. The BoE is expected to increase interest rates again when it meets in August, in a bid to stop inflation spiralling out of the control. Inflation is forecast to rise to around 11% this year.

In summary: 

• Inflation in the UK is being driven by Covid-19, Russia's invasion of Ukraine, and supply chain-related issues. These shortages are driving prices higher, making the cost of living more expensive 

• Should this rate of inflation continue, savers, homeowners, pensioners and lots of other people will be looking at some challenging times ahead 

• Inflation is likely to continue throughout 2022, expected to hit double digits later this year. 

• Governments and central banks are trying to control inflation by increasing interest rates. 

In such challenging times, getting the right financial advice for your circumstances is key.

Find your perfect financial adviser now. 

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