What is inflation?

Regardless of your financial situation or employment status, it’s important to have a basic understanding of inflation because of its impact on our everyday lives. Several factors determine inflation, but how does inflation affect us? On this page, you’ll learn how inflation works, what causes it, different types of inflation indexes and how it’s managed.

Inflation is a quantitative measurement of the rate at which the price of goods and services rises or the purchasing power of a currency falls. By definition, inflation is the increase in the cost of living due to increases in the prices of goods and services. 

The inflation rate is a percentage used to determine the increase or decrease of prices during a specified period, typically up to a year. The inflation rate helps you decipher how quickly prices rose during a specific period.

Inflation is affected by the supply and demand for goods and services. In an open market where the demand for a product is great, the price for that product might also increase as supply diminishes due to people purchasing. We probably all remember the surge in demand for toilet paper, flour and milk during the ‘Covid years’. By contrast, if the supply is greater than the demand, then the prices of the goods or services may decrease, tempting people into buying them.

The most common cause of inflation is what’s known as ‘demand-pull’ inflation, which happens when the demand for goods or services is higher than the supply. As people want to purchase a specific type of product, they are willing to pay a higher price. 

‘Cost-push’ is another cause of inflation, which happens when supply is short but the demand is not, although it’s less common. For example, if a natural disaster damages gas supply lines, there could be a shortage in the gas supply, but demand wouldn’t change. 

Another cause of inflation is money supply, which happens when a government prints too much money, resulting in too much capital for the volume of goods available and creating either demand-pull or cost-push inflation. 

The final cause of inflation is called ‘built-in inflation’, which happens when people expect wages to increase as the price of goods increases. However, higher wages mean the cost of production also increases, and this, in turn, raises the price of goods and services again. Built-in inflation creates a continuous cycle that can greatly affect the economy. 

Central banks usually manage inflation by using monetary policy to try and avoid it increasing too much. Monetary policy is an action that a country’s central bank can take to influence how much money is in the economy, and how much it costs to borrow. For example, the Bank of England is targeting a UK inflation rate of 2% over a year. 

A central bank can agree to increase the inflation rate over 2% in a bid to help improve the employment rate. If they do this, they will usually try and get back to the 2% inflation rate as quickly as possible, while allowing the rate to increase over a set period, especially if it has been low for a while. 

The Consumer Price Index (CPI) is the measurement of the inflation of consumer prices in the United Kingdom. It measures the average price of food, transport and healthcare. The CPI is calculated by averaging out the price change of each item from a predetermined list of goods and services, and is used in calculating the rate of inflation.

The current rate of inflation in the UK is 4% (as of 14 February 2024), and the current CPI is 4% (January 2024). 

This chart shows the UK’s historic inflation rates:

In most countries, including the UK, the target inflation rate is 2% because a little inflation means people will buy products sooner, making it easier for companies to pay wages. Both of these factors lead to economic growth. If wages can’t keep up with inflation, purchasing power and standards of living may fall. 

In the UK, the surge in inflation during 2023 – largely fuelled by soaring energy costs – led to a cost of living crisis because people’s pay failed to keep up with rising prices, following Government austerity policies from 2010 to 2015 and then again from 2016 to 2019. As a result, more people than ever had to turn to food banks in order to eat – the Trussell Trust reported a 37% year-on-year increase in 2022/23.

As we’ve seen, there are two main types of inflation; demand-pull and cost-push. Demand-pull inflation is when there is more demand for goods and services than there is supply, causing an increase in prices, due to the shortage of goods. 

Cost-push inflation is when the cost of creating or making the goods increases, and gives companies no choice but to increase their prices. For example, if the price of oil increases, a company that uses oil in their manufacturing processes may also increase the price of their goods, to make up for the oil price increase. 

Aside from these two types of inflation indexes, there are other types of inflation to know about, which are:

• Disinflation – when the rate of inflation falls, but prices are still rising in small amounts
• Deflation – the direct opposite of inflation, deflation happens when the rate of inflation drops below 0%, making goods and services cheaper. Although this may sound like a good thing, it may have other effects on the economy. One such effect is that people spend less because the value of money is high. Deflation generally encourages people to save rather than spend
• Stagflation – this happens when there is no economic growth and unemployment is rising with inflation. This means people’s wages fall, even as the price of goods and services rises
• Reflation – this signifies the start of an inflation cycle after a recession has occurred. It can refer to a growing economy in conjunction with rising prices of goods and services.

Stocks often beat inflation over the long-term, because companies can increase their share price to keep up with the rising costs brought about by inflation. 

For example, if wages and production costs increase because of inflation, a company could pass on these costs to their consumers by raising their share prices, and the cost of their goods or service. 

At Raisin UK, our marketplace is home to savings accounts with high interest rates from a range of partner banks, including savings accounts with inflation-beating rates*. Our fixed rate bonds tend to offer the most competitive rates of all account types, making them an ideal choice for long-term savings goals. 

However, if you prefer to have a degree of flexibility, notice accounts may be a better option. They require you to give a short notice period to withdraw money, typically between 30 and 90 days, but offer more competitive rates of interest than easy access savings accounts.

Apply for a Raisin UK Account today

It’s free to register for a Raisin UK Account, and you can apply for any savings account in our marketplace for free in a few clicks, so why not see how you could grow your savings and beat inflation?

As the years go by, it’s not uncommon to see the prices of our favourite products rise to meet inflation. Over the past twenty years, inflation in the UK has risen by 69.43% according to ONS data. But just how many of our favourite products have risen above, inline or below the rising cost on average in the UK?

Is there anything more British than remarking on the price of a Freddo? Our research has revealed that the frog-shaped chocolate bar has increased in cost by 70% since the year 2000, and while it will still on average only set you back 17p, that’s enough to earn the wrath of any snacking shopper. 

But it’s not just the infamous amphibian that’s putting more pressure on people’s pockets. We look at how the cost of everyday items has increased over the past 20 years, showing how inflation is impacting our outgoings and – in some cases – even saving us money.

It will cost you 181% more to send a letter than in 2000

The price of stamps tops our inflation hit-list, with their cost skyrocketing over the past two decades. Back in the year 2000, when Bob the Builder’s ‘Can We Fix It?’ spent three weeks at number one, you could buy a 1st Class stamp for a mere 27p. Today, if you want your letter to reach its destination by the next day, you’ll have to fork out a whole 76p to help it on its way. Who knew being a stamp collector could set you back so much?

A loaf of bread will cost 98% more dough

Another high flyer for inflation is a loaf of bread. At the turn of the millennium, a loaf of white, sliced bread would only cost you 52p, but 20 years later and the price has gone up to £1.03.

Bread isn’t the only food to cost more to chow down on. The price of a Big Mac, once a tasty bargain at £1.09, will now cost fast food feasters £3.39 – a whopping 78% increase. A packet of crisps has also seen a 40% rise (from 30p to 42p), while a 99 ice cream doesn’t – as the name suggests – only cost 99p. That price disappeared in 2000, with the 2020 price now a whole £1.50. Meanwhile, the demand for avocados has also impacted their price. A 38% increase has seen their cost shoot up from 72p to 99p, showing how changing tastes have brought about higher price margins. 

Methodology

Using data from the ONS Consumer price inflation time series and available information on historical prices, we’ve calculated the percentage increase in the price of these products from 2000 to 2020. Measured against the UK’s inflation rate (which has increased by 69.43%), we can determine if products are rising faster or slower than the average rate of inflation.

* At the time of publication (December 2020), the rate of inflation in the UK according to the ONS was 0.9% and the Raisin UK savings marketplace featured savings accounts with rates that exceeded this amount.