Illustration by Veronika Vieyra

Inflation has become a top concern for everyone, with the cost of living going up while salaries mostly staying the same. We’ve seen inflation hit 9% in the UK in April, the highest rate in 40 years, and the Bank of England even warned that it could surpass 10% later this year as the energy price cap has been lifted and the economy continues to be affected by Russian’s invasion of Ukraine.

But what exactly caused inflation and how does it affect your finances?

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What is inflation?

Inflation is an indication of how much prices of everyday goods have gone up since last year. 

For example, if a loaf of bread cost £1 last year and £1.07 now, that’s an annual inflation rate of 7%. So inflation can be understood as a rise in prices - which means you can now buy less things with your cash. 

Inflation in the UK is announced monthly in the Bank of England’s Consumer Price Inflation reports. In the latest report, it has reached 9% in the 12 months to April.

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What causes inflation to go up to 9%? 

It’s always a complicated question to answer, but the main causes this time around seem to be:

1. Fuel prices: Petrol and diesel prices have hit new record highs at 167.6p and 180.9 per litre respectively. Efforts to move away from importing Russian diesel have resulted in the tightening of supply and pushed up prices for retailers.
2. Energy price cap: Millions of households are seeing their energy bills going up by £693 a year. Energy companies have also seen the wholesale prices they pay affected by the war in Ukraine and continuing pressure on gas supplies.
3. Effects of Covid-19 which caused disruptions in supply chains around the world, especially in China. Many businesses struggle to have enough goods to sell, and prices have risen as a result of too many buyers chasing too few items.

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How inflation affects your money

Cost of living rises

You may have noticed the spike in prices of almost everything, especially when you go grocery shopping or fill up your gas tank. 

The main upward price shifts over the 12 months to April:

• Natural gas - 95.5%

• Electricity - 53.5%

• Motor fuels - 31.4%

• Furniture and maintenance - 10.7%

• Restaurants and hotels - 8%

• Food and non-alcoholic drinks - 6.7%

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It’s more expensive to borrow money

When inflation rises, the Bank of England increases interest rates to slow it down, which causes the cost of borrowing to go up. This is to encourage people to save more and spend less, which calms high levels of demand.

Higher interest rates will make it more expensive for homeowners to pay off their flexible mortgage. Interest charge on credit cards, bank loans and car loans will also go up.

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Your savings are losing value

Although rising interest rates give the money in your savings account a higher return, they are not any close to the pace of which prices are rising because banks are offering extremely low interest rates. 

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Your salary might not keep up with inflation

A survey has shown that employers expected to give their staff a 3% wage increase this year, a rate well below inflation. If your manager promises you a pay rise at any rate lower than inflation, that would translate into a pay cut.

This is mainly because companies are not used to factoring high inflation into wages. When they discussed salary budgets for the coming year, they didn’t anticipate that inflation would be going crazy.

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What you should do in times of high inflation

Put your money into long-term investments 

Investment accounts are the only accounts that are capable of returning higher interests than inflation. If you’re worried about losing all your money picking stocks, then, have a look at index funds. An index fund can be seen as a basket of different stocks so your investment would be diversified which lowers the risk. What’s better is that index funds are passive investments - all you need to do is set in some money and forget it.

You can open a Stocks & Shares ISA, buy some index funds, set up monthly transfers into the account, and let compound interest work its magic. 

Other types of investments that act as a “hedge against inflation” (their value goes up when inflation rises) include property, gold and precious metals.

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Negotiate a pay rise or switch to a new job

A survey pointed out that employers only planned to give an average pay rise of 3% this year. But trust us, you can ask for more - it is more expensive for them to hire new people than to hold onto good employees. 

You can’t, though, ask for a pay rise by just mentioning how your finances can’t keep up with inflation. You’ll need to back to research your market value and have records of your good performance and figure out how much you want to aim for based on typical pay rises within your market and within the company over the past few years, all keeping inflation in mind.

Another factor to take into consideration is non-salary benefits. If your company has stated that they don’t have the budget for a pay rise. Some things you could negotiate are flexible hours, fewer days in the office, a four-day work week, or a title change. 

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Set your savings goals

As a general rule, the money you will need for your short-term goals (within 1-2 years) should not be invested but kept in a savings account that generates as much interest as possible. 

Keep an eye on the interest rate your savings accounts are paying - some banks offer a high introductory rate but reduce it after the introductory period ends, so pay attention and see if you need to move your savings into a higher-paying account.

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DeFi

If you’re familiar with crypto, you can even consider using stablecoins to get a much higher interest rate (7-8%) than traditional savings account without the price volatility. You can use a service like BlockFi or Coinbase to buy stablecoins such as DAI or USDC and the platform lends it out for you to generate the return.

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Consider investing in property

Property is a good hedge against inflation as housing values historically increase over time - average house prices in the UK h ave risen by more than 20% since 2017. If you’re thinking of selling your old home, you’re in a strong position to lock in some sizeable gains. If you’re looking to buy one, you might want to get a fixed interest rate.

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