What does inflation mean and why is it so high?

Wondering what does inflation mean? You're not alone. This guide explains what you need to know including how rising inflation affects the pound in your pocket

Woman with coins and purse in hand
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We all know prices are going up due to inflation – but what does inflation mean?

“Inflation can be caused by different factors. In simple terms, shortages of things tends to push the price up”, says Rob Burgeman (opens in new tab), Investment manager at Brewin Dolphin. “So, the war in Ukraine and the sanctions on Russia have disrupted the supply of things like oil, gas, wheat and fertiliser. As these prices go up, people start to demand more pay simply to maintain their standard of living. You then have more money chasing the same amount of goods which pushes prices up further.”

With costs going up all around us, families are understandably concerned over how much their energy bills will cost (opens in new tab), how to save money on food (opens in new tab) and looking for ways to save on petrol and diesel costs (opens in new tab), but it's important to understand the underlying causes of the rising prices as well as how to combat them. 

What does inflation mean?

Inflation, essentially, is the change in prices over time. The inflation rate, also known as the Consumer Prices Index, is the measure used to work out how much prices have gone up or down by.  

The number crunchers at the Office for National Statistics (ONS) check prices across an extensive range of goods and services to produce one overall inflation figure. This overall figure covers the rising cost of everything from your weekly food shop to the cost of filling up your car and household bills like energy and insurance.

The ONS checks the prices across 700 goods and services – items that most households typically buy – including food, clothing and household items to work out if we’re paying more for these items than we did at the same time last year.  

Over 180,000 prices are checked across 140 UK locations as well as online and by phone to get the most accurate and up-to-date pricing. 

Right now, inflation is at 9.4%, which is the highest it’s been in 40 years. This means we’re paying, on average, 9.4% more for the goods and services we buy than we were at the same time last year.  This is considerably higher than the Bank of England’s target inflation rate of 2%.

Why does inflation happen?

Inflation happens because the price of goods and services go up. This can be due to the cost of producing or making certain items. Take furniture for example. If materials are coming from overseas and transport costs have gone up, this can increase the price tag. 

Inflation can also occur due to a surge in demand for certain items, say if something is in short supply, then prices may go up simply because people are willing to pay more for it. This is part of the reason energy prices are going up.

Why is inflation so high?

There’s no one single reason why inflation is so high right now. One big factor is due to soaring energy costs. We’re paying more for our gas and electricity because the wholesale price – the price at which energy suppliers buy their energy - has gone up due to the conflict between Russia and Ukraine.

Petrol prices are also at record levels – also triggered by the situation in Ukraine and prices are rising on the supermarket shelves, due to increased manufacturing and transport costs.  This means many of us expected to be paying nearly £400 a year more for the same trolley load over the next year. 

However while the current 9.4% inflation rate is the highest for 40 years – it has gone higher in the past. It peaked at 25% back in the 1970s.

What happens when inflation rises?

Depending on whether the inflation rate stays steady or jumps up will have an effect on how far your money goes.

When inflation is high, you get less for your money as prices go up. At best, this means that you have less disposable income to spend on wants rather than needs at the end of each month. For others, rising prices can cause serious money worries, especially if families don’t have enough money to cover necessities. 

Les Cameron (opens in new tab), savings expert at M&G Wealth, says: “Inflation will hit people in various ways, so depending on your age and lifestyle your reality may seem wholly different,”

“Those spending a lot of time at home may feel they are experiencing much higher inflation, with increased energy and food prices and, for many, the dramatic rise in the cost of fuel is taking its toll”.

Why do interest rates rise with inflation?

Interest rates often rise with inflation as a way to curb rising prices. 

If interest rates go up, it costs more to borrow money on everything from mortgages to loans and credit cards. The result is that people are likely to spend less.

“This is a deliberate strategy by the Bank of England to slow down the economy and take some of the steam out of the inflation engine”, says investment expert Rob Burgeman.   

Interest rates are set by the Bank of England, and are also called the bank rate or the base rate. Any change the Bank of England makes to its base rate – which is currently 1.25% – filters through to the mortgage, loan and credit card rates charged by banks and building societies.  This ultimately means you will pay more to borrow money and, in turn, have less spare cash to spend.

While any interest rate rise initially affects mortgage borrowers who are paying their lender’s Standard Variable Rate (SVR), even those on fixed deals may find mortgage rates have gone up when their current deal ends and they look to shop around for a new one.

Sue Hayward is a personal finance and consumer journalist, broadcaster and author who regularly chats on TV and Radio on ways to get more power for your pound. Sue’s written for a wide range of publications including the Guardian, i Paper, Good Housekeeping, Lovemoney and My Weekly. Cats, cheese and travel are Sue’s passions away from her desk!