Inflation – what does it mean for your savings?

Inflation is the increase in prices over time. It’s happening constantly – things are generally more expensive than they were a few years ago.

To see it happening, think about what you could buy with £1 over the past few decades.

We’ll look at it in terms of loaves of bread:

1970: £1 = 10 loaves of bread

1980: £1 = 3 loaves of bread

1990: £1 = 2 loaves of bread

2020: £1 = 1 loaf of bread.

So, £1 can buy you much less now than it could in 1970 and in another ten years it will buy even less. In fact, in 2024, the average price of a loaf of bread is £1.40, so that same £1 would now only buy 0.7 loaves of bread. This is due to inflation. This is known as the “purchasing power” of money.

The most used measures of inflation in the UK are the consumer prices index (CPI), the consumer prices housing index (CPIH) and the retail prices index (RPI).

Each measure is calculated slightly differently, although RPI is usually the highest.

While you don’t need to know how each measure is calculated, it’s useful to know the current rate. This is because different rates are used for different things.

For example, RPI is typically linked to final salary pension payments, car tax and interest on student loans. CPI is often used by the government for things like calculating the state pension, and benefits like Universal Credit.

If you hear the inflation rate is high, that means you can buy less this year than you could last year for the same amount of money, and this reduction in buying power is happening at a higher speed than usual.

Inflation is measured as a percentage:

• If the inflation rate is 1% (lower inflation), the purchasing power of money will be 1% less a year later.
• If the inflation rate is 5% (higher inflation), the purchasing power of money will be 5% less a year later.

It's important to know the inflation rate when thinking about savings and investments because it affects whether you make a profit after inflation.

For example, if you put your money in a bank account that pays 1% interest, you'll have 1% more money after a year. But if inflation is more than 1%, your money won't buy as much as it did before.

Let’s say, you have £100 and can buy something for £100 today. If you save your money in a bank account with 1% interest, you'll have £101 next year. But if inflation is 5%, that item will cost £105 next year. With £101, the money in the bank would no longer be enough to buy it.

To make money on your investment, you need an account or investment that gives you a return higher than the inflation rate.

Savings goals are the things you want to achieve in future, whether it’s buying a new car, saving for retirement or sailing around the world.

Once you’ve set your goals, you can work out how to achieve them – some will be suited to long-term investments, some to short-term savings.

Some savings accounts are index-linked which means they’ll pay interest that tracks inflation but won’t always keep up with other interest rates.

These get more expensive when the markets are expecting inflation to rise, so the overall return might not beat inflation.

There’s no sure way to protect your money from the effects of inflation.

The only rule is that cash savings accounts are generally not the best places to put your money long term – the interest is almost always lower than inflation, so your buying power is reduced.

Savings accounts still have their uses, especially for money that you want to spend soon.

But if you’re planning to put money aside for five years or more, it might be better to invest.