For example, if the cost of a litre of gasoline rises by 2% every year, motorists must pay 2% more at the pump than they did a year ago. If salaries do not keep pace with inflation, purchasing power and standard of living to suffer.
A little inflation, on the other hand, usually stimulates individuals to buy things sooner and makes it simpler for businesses to raise salaries. Both of these factors contribute to economic growth.
As a result, most countries' central banks set an inflation goal of between 2% and 2.5%. In the United Kingdom, the government has established a 2% inflation target for the Bank of England.
How is inflation calculated?
The Office for National Statistics calculates inflation (ONS).
It generates three major inflation estimates:
- the Consumer Price Index (CPI);
- the Consumer Prices Index, which includes housing expenses for owner-occupiers (CPIH)
- and the Retail Prices Index (RPI).
The CPI is the most frequently cited figure. It examines the cost of thousands of items that customers frequently purchase, such as movie tickets, bicycles, and even smart speakers.
What is its purpose?
Inflation is one of the primary factors considered by the Bank of England when determining the "base interest rate". This affects the interest rate at which banks can charge consumers to borrow money or the rate at which they can save money.
If the Bank of England believes that inflation will be less than 2%, it may lower interest rates to reduce the cost of borrowing and therefore promote expenditure.
In March, in response to the coronavirus outbreak, the Bank lowered interest rates to a historic low of just 0.1% in order to bolster the economy. Inflation has a direct impact on certain people's salaries as well. State payments and many occupational pensions increase in line with the Consumer Price Index (CPI). Currently, the basic state pension is governed by the so-called triple-lock. This means it will rise by whichever is greater: the CPI, average earnings, or 2.5%.
In addition to the cost of some railway tickets, repayments on student loans and government bonds are also linked to RPI.
Is there anyone who benefits from inflation?
It's vital to remember that inflation is merely an average rate based on certain products. Its impact on a household's finances is determined by its unique circumstances.
Borrowers may gain from it. Anyone with a fixed-rate mortgage, for example, gains from inflation because it effectively cuts their debt.
Governments may benefit if high inflation erodes the value of their loans. However, for savers, including those planning for retirement, inflation reduces the amount of money that may be saved in the future.
Inflation has an impact on everything from mortgages to the cost of our groceries and train tickets. According to the most recent UK inflation numbers, the rate increased to 1.5% in April, up from 0.7% the previous month. Persona Finance [enquiries@personafinance.co.uk] can help with accounting and business guidance.
