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What does the record leap in UK inflation mean for me?

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The headline rate of inflation in the UK has recorded its biggest ever jump, leaping from 2% in July to a nine-year high of 3.2% in August. Earlier this summer the Bank of England said it expected annual price rises to hit 4% before the year was out, before dropping off slightly.

What is inflation?

It is the measure of how much prices are rising and falling and is tracked by several different indices. The main one used by economists is the consumer prices index (CPI), which records the cost of a basket of 700 items including food, transport and entertainment. The Bank is tasked with keeping inflation at 2% but it has been above that already this year and is now much higher.

Why is August’s figure so high?

The rate is a year-on-year comparison, so a monthly jump in inflation does not mean prices have risen by that much since July. The Office for National Statistics, which publishes the figures, said higher prices in transport, restaurants, hotels and for food and drink had driven the rate up in August.

It pointed out that in August 2020 the eat out to help out scheme was running – as a result, restaurant prices were artificially low, so will be much higher now in comparison, even if not in historical terms. However, staff and supply problems in the hospitality industry have also pushed up prices, while the cost of petrol at the pumps is higher than at any time since 2013.

What does this mean for me?

Moderate inflation is not a bad thing – people will be more likely to spend their cash if they think it will buy less in future. But high inflation has consequences. Most obviously, if you are on fixed pay then your money will not go as far each month.

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What if you are saving?

View image in fullscreenThe best one-year account for savings currently pays 1.5%. Photograph: Alamy

Rising inflation at a time when interest rates are at record lows is bad news – your money will not have the same buying power when you withdraw it as it did when you put it away. Put very simply, if you put away £100 last year, it would need to be worth £103.20 to have the same value in real terms. The best one-year account currently pays 1.5%, so your savings would be worth £101.50.

Moving into higher-risk investments is a way to try to beat inflation but there is always the chance you could lose money, too. “For people to have any chance of keeping their returns real, there are few options other than to move up the risk curve,” says Simon Lister, an independent financial adviser at the financial comparison website Investing Reviews. “For the risk-averse, it’s a rout at present.”

If high levels of inflation stay for longer than anticipated, the Bank may raise interest rates, which would be good news for those with cash on deposit.

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What if you are borrowing?

The opposite is true for borrowing. If you have a loan on a variable rate of interest, then a rise in the Bank base rate would push up your repayments. Fortunately, many people have opted for fixed-rate mortgages, and costs will remain the same even if the Bank does act.

And inflation reduces the size of your debt in real terms. If it leads to a pay rise, then the sum you need to repay each month will be less of your income than when you first took on the loan.

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What about student loans?

The rate of interest on student loans is linked to inflation, so a high rate sounds like bad news for many of those with university debts. The rate that matters is the RPI (retail prices index), which hit 4.8% in August, and students who have started university from 2012 are supposed to pay an interest rate of RPI plus 3.

The good news for them is that the rate is calculated based on March’s figure, not September’s when inflation is still expected to be rising. Also the rate is monitored against commercial personal loan rates, and altered accordingly. It has been capped below RPI plus 3, and the government may step in if RPI is still running high.

What about pay?

View image in fullscreenWill your workplace increase your pay in line with inflation? Photograph: Alamy

Most workplaces do not have to raise pay in line with inflation but it is often used in negotiations. Employers, who in some sectors are already battling with staff shortages, may have to increase wages to attract and retain workers who need to meet higher living costs.

And pensions and other benefits?

A number of benefits are linked to inflation, including the state pension. The government suspended the pensions “triple lock” last week, but committed to raising pension payments in line with CPI if September’s figure is above 2.5%.

September’s figure determines how much elements of universal credit and other benefits will go up next April, so they should keep up with rising costs. However, before then the temporary £20-a-week universal credit uplift will have ended.

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Some private pensions offer payments linked to inflation, so payouts should increase.