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UK inflation: what it means for house prices, savings and pay rises

·9 min read

There is no escaping inflation: whether it’s energy, food, transport or entertainment you are paying for, prices are going up – and at pace.

Once again this week’s headlines have been dominated by the latest figures – on Wednesday we learned that inflation had reached a 40-year high of 9%. Plus, there have been warnings of worse to come. But what does it all mean? We asked readers what questions they had about inflation and its impact, and have tackled them below.

First, a bit of background.

The rise in the cost of living is captured in the monthly inflation rates reported by the Office for National Statistics. There are several different rates recorded by the economists: the consumer prices index (CPI), retail prices index (RPI), and CPIH (CPI including owner occupiers’ housing costs). It is CPI that hit 9% last month. CPIH was 7.8%, while RPI hit 11.1%.

A woman browses in a supermarket
The cost of food, energy, transport, entertainment and more is going up. Photograph: Neil Hall/EPA

The rates are different because of the goods that are included in the price tables, and also because of the way the figures are calculated. RPI tends to be the highest. It is set to be scrapped in 2030 but is currently still used to set the student loan interest rate and annual increases in train fares.

Q Would 0% inflation be good?

Hilary Osborne: inflation is the rate at which prices are going up – it does not tell you how high prices are historically, just how much higher or lower they are than last year. So if this time next year inflation is 0%, that means prices will still be higher than in the same period in 2021.

That said, no one targets getting inflation to 0% or even below. Inflation of 2% is generally considered good – this is the rate that the Bank of England and other central banks target. This rate is high enough to encourage people not to sit on all of their cash and wait for prices to go down but low enough to allow people to plan and wages to keep up.

Banks generally react to rising inflation by adjusting interest rates upwards – the idea is that this will encourage people to save their money rather than spend it and reduce demand for goods and services.

Q The current inflation isn’t caused by an increase in demand or in wages – it’s caused by a rise in supply costs. This is in part caused by the war and Covid and the resulting shortages and supply chain problems but isn’t the real problem that commodity-producing corporates are taking advantage of their virtually monopoly positions?

Larry Elliott: this is right on the money. Traditionally, higher interest rates work when the economy is overheating and – the housing market apart – there is no evidence that it is. The UK’s national output of goods and services is only just above its pre-pandemic levels, so effectively two years of growth have been lost.

The Bank of England has admitted it can do little in the face of rising energy costs, and originally thought it would be possible to wait for inflation to come down without doing very much. It has now been spooked by evidence that inflation will stay higher for longer, and some signs that higher energy prices are feeding through into other parts of the economy. The risk of driving the UK into recession is clearly there. A windfall tax on the energy companies is going to happen, whatever the government currently says.

Q I’m a first-time buyer who has saved almost all of my target deposit. I want to get on to the property ladder to stop paying rent, and because my money is currently in the bank doing nothing. Is this a wise time to buy or should I hold off?

LE: the housing market is starting to cool down a bit but it is far too early to say there is going to be a property crash. For that to happen, there would need to be a sharp rise in mortgage rates and unemployment rather than the more modest increases that are currently predicted. That said, the willingness of people to take on big financial commitments is understandably weak at present, which suggests that house prices are not going to do much in the next year or so.

Cottages in Gloucestershire
Many people want to know what’s going to happen to house prices. Photograph: Neil McAllister/Alamy

Q Why is the annual increase in state pensions based on the CPI rate in September of each year? Would an average of inflation taken over the calendar year be a more equitable rate for the increase in April?

HO: September’s figure is used to give the government time to set up the change in payments. Steve Webb, a former pensions minister who is now a partner at the consultancy LCP, says that after the September figure is published in October, the Department for Work and Pensions needs to look at its data and announce plans to parliament – usually in November’s budget. The actual legislation to implement the changes doesn’t get debated until the start of the following year.

Money spilling out of pension pot.
The triple lock on the state pension was not used this year. Photograph: Trevor Chriss/Alamy

“There’s a lot of parliamentary process to go through (we are talking about billions of pounds of public spending) and time to change rates, especially for legacy benefits on old computer systems,” he says.

Each month’s figure is based on a comparison with prices the year before, so is always taking account of 12 months of changes. When inflation is fairly stable, September’s figure is arguably as good as any. Usually, the triple lock – the promise that pensions will rise in line with inflation, average earnings or 2.5% – irons out some of the ups and downs but this was not used this year.

A simple average of last year’s monthly CPI rates actually results in a smaller increase than the 3.1% rise this year because inflation was below 1% in the first part of 2021.

Q I work as a postman and we have only been offered a 3.5% pay rise. If we get a bigger increase, will that have an impact on inflation?

LE: higher pay awards are not causing inflation. Wages are a price like any other and reflect market forces. Higher pay will mitigate some (but not all) of the hit to living standards caused by rising inflation and should encourage people currently not working to look for jobs. That should help ease labour shortages, one of the supply-side constraints affecting the economy.

Q My son is buying a house. I am worried the likely rise in mortgage interest rates as a result of inflation will affect his budget. Can anyone give us some guidance on the outlook for peak interest rates?

HO: sadly, no one can tell you where interest rates will end up, although many people will speculate. Some economists have forecast the base rate going up from 1% now to 3% next year but most are not predicting such a big rise. The money markets currently suggest that the base rate will peak at just above 2% in about two years’ time. Mortgage rates are likely to be higher.

If your son already has a mortgage approved, then his budget should have been closely inspected by the lender and he should be well cushioned against interest rate rises. Before banks and building societies agree to a mortgage, they stress-test applicants, typically at a rate above the standard variable rate. They also look at income and outgoings when assessing if a mortgage is affordable. He will probably also have chosen a fixed-rate mortgage to protect himself against rises in the short-term.

If he is about to apply, rising rates will have an impact on what he is allowed to borrow.

Houses for sale in Cambridge, England
If you have already had a mortgage approved, your budget should have been closely inspected by the lender. Photograph: Eric Farrelly/Alamy

Q Is it worth saving these days?

HO: it’s a good question, given that any money held in a savings account is effectively falling in value. With inflation running so high, the cash you have saved will buy you less than this time last year because there are no accounts that will have paid you enough interest to keep up.

However, as Sarah Coles from the investment firm Hargreaves Lansdown points out, there’s a good reason to hold savings. “The last couple of years have shown us just how unpredictable life can be, and how much difference it can make to have something to fall back on when we’re hit with the unexpected,” she says. “Everyone of working age should be working towards a savings safety net of three to six months’ worth of expenses in an easy access account – which rises to one to three years’ worth when you have retired.”

This cushion means that if you are hit with an unexpected bill, you will not have to borrow to pay it.

Piggy banks on blue background
Money held in a savings account is effectively falling in value. Photograph: OsakaWayne Studios/Getty Images

“At the moment, any money in a savings account will be losing spending power after inflation but you should still make sure it works as hard as possible for you,” she says. She suggests an instant access account from Al Rayan Bank paying 1.31%. For a higher rate, she says you can earn 2.27% on a one-year fix with Al Rayan Bank, or 2.75% on a two-year fix with Market Harborough building society.

Pigeons are pictured in a general view of the Bank of England in the City of London
There is a limit to what the Bank of England can do about inflation. Photograph: Daniel Leal-Olivas/AFP/Getty Images

Q Inflation is 9% for the average person but how do I know what the impact is on me, as I may have a bigger mortgage than someone else, or buy different things?

HO: your personal inflation rate will depend on what you spend your money on – and how much goes on each element. Everyone buys energy but some people buy more of it, and some people have to use proportionally more of their income to pay for it. There are calculators where you can work out your personal inflation rate. The ONS has one on its website that lets you fill in exact numbers, as does the investment firm Rathbones. These will help you see where your money is going and will be helpful for financial planning.

Q Is there another way for the Bank of England to fight inflation apart from raising the base rate?

LE: there is a limit to what the Bank can do, given the tools at its disposal. In essence, it can make the cost of borrowing more expensive by raising interest rates, or it can suck money out of the economy through a process known as quantitative tightening, which involves selling the bonds it has accumulated since the financial crisis of the late 2000s. However, base rates and QT are blunt instruments. It is the chancellor, Rishi Sunak, who the country should look to for action.