What is inflation and how does it affect you?

Key takeaways

• Definition: Inflation measures how much prices for goods and services increase over time, currently tracked via the Consumer Prices Index (CPI).
• Current status: UK inflation is currently 2.8%, which is the first fall this year but remains above the Bank of England's 2% target. Experts warn this could be the calm before the storm.
• Savings impact: Inflation can lead to higher savings rates because banks often raise their interest rates when borrowing costs increase. However, inflation also reduces the value of your money over time, so having a competitive savings rate is important to help protect its purchasing power.
• Mortgage impact: High inflation often leads to the Bank of England having to keep the base rate higher for longer, which in turn causes mortgage lenders to increase their own mortgage interest rates. Those already on fixed-rate mortgages are shielded from rate increases until their deal ends, while variable rates fluctuate with market changes.

What is inflation in simple terms?

Inflation is when prices across the economy rise over time, which means money buys less than it used to. If a coffee costs £2.50 today and £2.75 next year, that's a small example of inflation at work. So the inflation rate is the measure of how much the price of products or services has increased over time.

To work out the inflation rate, the Office for National Statistics (ONS) tracks the prices of everyday items by creating an imaginary ‘basket of goods’ - 744 items to be exact. This is known as the Consumer Prices Index (CPI), but you might also see it as Consumer Prices Index including housing costs (CPIH).

A small amount of inflation - around 2% - is considered normal and healthy. The problems start when it rises too fast: it erodes purchasing power, squeezes household budgets, and can push up the cost of borrowing, including mortgage rates.

What causes inflation?

Inflation is usually caused by one of two things: demand-pull or cost-push inflation. Demand-pull inflation happens when people want to buy more than businesses can supply, for example, during a period of low unemployment and high consumer confidence. Cost-push inflation happens when production costs rise, forcing businesses to charge more to their customers.

A sharp rise in energy or oil prices is one of the most common triggers. The surge in UK inflation to over 11% in late 2022 was driven largely by soaring energy costs after Russia invaded Ukraine. More recently, rising oil and gas prices linked to the conflict in the Middle East pushed UK inflation back up.

Although the latest inflation figures show it is decreasing, this is likely to be temporary, as the market is expecting inflation to rise again. Rising fuel and food prices are expected to pull inflation closer to 4% this summer, and if the conflict in the Middle East sees any escalation, this could cause it to go even higher than this.

Is inflation good or bad?

A small, steady amount of inflation is generally seen as a sign of a healthy economy. The Bank of England targets a 2% inflation rate, which is enough to keep the economy moving without eroding people's spending power too quickly. When inflation stays close to that level, wages tend to keep pace, and mortgage rates stay more manageable.

However, when inflation rises sharply - as it did in the UK in 2022, hitting over 11% - it becomes damaging. It reduces what money can buy, puts real pressure on household budgets, and often forces the Bank of England to keep interest rates higher for longer. This feeds through to higher mortgage rates, making borrowing more expensive. The reverse - deflation, where prices consistently fall - can also cause problems, as it can lead people to delay spending and slow down economic growth.

What is the current inflation rate in the UK?

The latest inflation figures show that the current inflation rate (CPI) in the UK is 2.8%, down from 3.3% the month before, and still way above the Bank of England's 2% target. Although lower inflation is a welcome relief, this is likely to be temporary, as the market is anticipating inflation to climb closer to 4% over the coming months as we see the impact of the conflict in the Middle East start to fully trickle through to the economy.

If inflation does rise, it's likely the base rate will stay higher for longer and may not be cut for the rest of 2026. As mortgage lenders price in base rate cuts before they happen, if a base rate rise looks more likely, we could see lenders start increasing their own rates. We're already seen average mortgage rates jump back above 5% as lenders rapidly repriced fixed-rate deals off the back of rising inflation fears, although some have begun to cut rates again. See what rate you could get now without applying.

How does inflation affect you?

In short, inflation means your money can't buy as much today as it could in the past. It impacts the general cost of living because when inflation rises, the price of everyday items and services increases too. Interest rates also tend to increase, impacting the rates people can get on loans like mortgages and savings accounts. Rising inflation also means that wages have to work harder to keep pace with these increases; otherwise, earnings won't go as far as before!

When a person’s wages fail to keep up with inflation, they’ve effectively been given a pay cut. This is because their 'real income' — that’s their earnings adjusted for inflation — falls, meaning their salary won't stretch as far if the cost of food, clothes, energy, petrol, and other living expenses has risen at a much faster rate.

Recent figures highlight the gap between nominal and real wage growth:

• Average wage growth: 4.1%
• Growth in real terms (adjusted for inflation): 0.8%

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How does inflation affect savings rates?

Inflation has a big influence on mortgage rates because it directly affects the Bank of England's decisions on the base rate. Inflation impacts interest rates for savings by influencing what rates savings providers can offer their customers. The Bank of England charges other banks and lenders to borrow money through the base rate. When the base rate goes up or stays high, this makes it more expensive for providers to loan money to their customers, so they typically will also raise their interest rates in response.

Inflation also impacts the purchasing power of your money. High inflation erodes the purchasing power of your money over time unless the interest you earn on your savings outpaces inflation. Banks may respond to high inflation by increasing savings rates to attract deposits, but the rates offered by big, well-known providers often still lag behind inflation. This is why looking for the most competitive rate - not just the biggest name - can help you make your money work harder and protect its purchasing power over time.

How does inflation affect mortgage rates?

When inflation drops, this gives the Bank of England more wiggle room to reduce the base rate. This is the rate the Bank of England charges other banks and lenders to borrow money, and is a lever the Bank can pull to curb inflation when it rises too high. The base rate was increased multiple times over 2023, but over 2024 it was cut twice, with the base rate now standing at 3.75% and is expected to stay at that level or even rise over 2026.

When the base rate goes up, this tends to influence mortgage lenders to increase their own interest rates. This can be bad news for borrowers, as it can lead to higher borrowing costs, making their debts less affordable, including mortgage repayments. But it's good news for savers if savings interest rates stay high, helping you to make your savings work harder.

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Does inflation affect fixed rate mortgages?

Not while the fixed term is active. If you have a fixed rate mortgage, you won’t see a change in your monthly payments when the inflation rate rises until the end of your fixed term. When your fixed term expires, you’ll usually be moved onto your lender’s standard variable rate, which rises and falls based on changes in the market, or you can remortgage onto a new fixed rate deal.

In the months before your fixed rate expires, it’s a good idea to start looking for a new mortgage deal. Luckily, this is something we can help you with. Our smart tech will compare thousands of mortgage deals across the market in an instant to find which ones you’re eligible for. Complete your details online to get started. 

Should I fix my mortgage?

If you’re on a variable rate mortgage or your current fixed rate mortgage deal is coming to an end, we recommend looking at both fixed rate and variable deals to compare what’s available. During periods of market volatility, a fixed deal can protect you from fluctuations.

For example, in the 1990s and early 2000s when interest rates fluctuated between 3.5% and 14.88%, those lucky enough to fix at the lower end of the scale were offered a lot of protection. 

Equally, a variable rate mortgage can offer an opportunity to access lower interest rates and therefore lower monthly repayments. To understand whether a variable rate might suit you, calculate what your monthly repayments would be with the current market rates on variable mortgages. To test your affordability, calculate your monthly repayments by adding the following to current variable rates:

• Current rate + 1%: Can you still afford the monthly cost?
• Current rate + 2%: Would this stretch your budget too far?
• Current rate + 3%: Is this a financial risk you are willing to take?

It’s always best to seek expert advice when it comes to deciding whether to fix your mortgage or not. If you feel overwhelmed looking at the different rates available, get in touch with our expert team.

Read more: How long should I fix my mortgage for?

Is inflation an issue in the UK?

While inflation has come down significantly from its peak of over 11% in 2022 - driven largely by soaring energy prices after Russia’s invasion of Ukraine - it had been hovering close to the Bank of England’s 2% target since mid-2024. However, inflation has started rising again on the back of the conflict in the Middle East.

If inflation continues to climb, a base rate cut will become less and less likely. The Bank will need to balance cutting rates too soon with supporting the economy that's grappling with higher inflation. If anything, we're more likely to see the base rate increase than come down now. This will likely result in mortgage rates and savings rates rising.