Inflation has become the hot topic in financial circles. Low interest rates and quantitative easing, the process by which central banks pump new money into the economy may well be vital to getting the economy running again – but they can both also stimulate inflation.

So how could inflation affect you – and should you be worried?

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Who suffers from inflation?

People on a fixed income.  A pension annuity offering a generous retirement income when you stopped work can feel much smaller twenty years later. The amount coming in each month is the same, but it buys much less.

Savers. The interest your money earns in a savings account is no longer enough to keep pace with inflation. Your savings fall in real value, and when you draw out your cash it will buy less than it did when you put it away.

Who benefits from inflation?

Homeowners. The value of homes increases with house price inflation, potentially turning a small home into a big asset.

Mortgage borrowers. Anyone with a mortgage, and especially a fixed-rate mortgage benefits from inflation, as it will reduce the real value of their debt,

Borrowers. Individuals and businesses find it easier to pay back historic loans if the value of money falls.

Should we be worried?

Inflation is simply the age old process of rising prices. It can happen for a number of reasons, and inflation can be a problem, because it affects what you can buy for your money. When there is inflation, money doesn’t go as far. When your wages don’t keep up with inflation, your purchasing power is reduced and your standard of living falls.

Inflation is measured as a percentage increase or decrease in prices over time, and in the first two decades of this century, it averaged around 2% a year.

That 2% may not sound a lot, but when inflation is sustained, the effects are multiplied. 2% annual inflation means that prices in 2021 were nearly 50% higher than in 2000. An item that cost £10 in 2000 would cost around £15 in 2021.

The average increase in prices is known as the inflation rate. So if inflation is 3%, it means prices are 3% higher (on average) than they were a year ago. For example, if a loaf of bread cost £1 a year ago and now it’s £1.03 then its price has risen by 3%.

Inflation also reduces the purchasing power of money since more money is now needed to buy the same items. High rates of inflation mean that unless income increases at the same rate, people are worse off. This leads to lower levels of consumer spending and a fall in sales for businesses.

As the global economy emerges from lockdown, pent-up demand and supply chain bottlenecks mean demand exceeds supply in many sectors,leading to price increases.

This might not be a problem if your income rises in line with inflation. But if it does not, inflation can become very painful.

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What is really happening?

Back in May 2021 the UK inflation passed the 2% mark as recovery started to gain traction.

In the Uk ,the Consumer Prices Index (CPI) rose by 5.1% in the 12 months to November 2021, up from 4.2% to October. This is the highest CPI 12-month inflation rate since September 2011, when it stood at 5.2%. On a monthly basis, CPIH rose by 0.6% in November 2021, compared with a fall of 0.1% in the same month a year ago.

Many observers think this is just the beginning.The Office for Budget Responsibility forecast inflation would reach 5%. Economists now expect the RPI measure of inflation to run at around 6% next year for months, and peak at 7.1% next May.

Figures released in mid-November 2021 by the office for national statistics suggested that the cost of living has already surged by 4.2% in the 12 months to October, the highest rate in almost 10 yearsThis is mainly due to higher fuel and energy prices but the cost of second-hand cars and eating out also rose. The costs of goods produced by factories and the price of raw materials have also risen substantially and are now at their highest rates for at least 10 years.

So what can you do?

As an individual there islittle you can do to resist the tide of inflation. But you should probably factor it into your financial planning. That means looking at the goals you set for your pension and other savings, and possibly setting them higher.

Inflation can obviously pose serious threats to businesses. Now is the time to look your buisness strategy and at how inflation can affect your business, the risks involved, and methods of protecting yourself against inflation.

Although inflation can eat into the value of cash savings, it can support a rise in the value of investments.

Don’t let inflation become a problem. Get in touch for Help and Guidance.