Leanne Macardle

Leanne Macardle

Editor
Published: 07/12/2018

At a glance

  • Inflation can cause the value of money to drop over time.
  • Savers need to try and find an interest rate that at least matches the rate of inflation to maintain the purchasing power of their money.
  • Long-term bonds and one-year bonds are options when it comes to combatting the effects of inflation on savings.

What is inflation?

An economist will tell you that inflation is the term used to describe the general rise in the price of goods and services over a period of time.

Put another way, inflation is when money loses value over time.

Think about it in terms of how many loaves of bread you could maybe buy with £1 now compared with years gone by.

In 1970, £1 may have got you 10 loaves of bread, but by 1980, that same £1 would only have bought you three loaves. Right now, it may just about get you one loaf.

So, £1 now will buy you less than what it would have bought back in 1970 – that is due to inflation, and a reduction in the purchasing power of money.

The rate of inflation

Inflation is calculated as a percentage, so if a loaf of bread cost £1 this time last year and £1.05p now, then the annual rate of inflation on a loaf is 5%.

By looking at the changes in the price of a whole host of goods and services, economists work out whether the cost of living in general is going up or coming down.

In the UK, the two main measures of inflation are the Consumer Price Index (CPI) and the Retail Price Index (RPI).

RPI is usually higher than CPI because they each look at a slightly different 'basket' of goods and services – RPI, for instance, includes housing costs such as mortgage interest, rent and council tax, whereas CPI does not.

What is the effect of inflation on savings?

When it comes to savings, you would always like to find an interest rate that at least matches the rate of inflation, so you can at least preserve the purchasing power of your money.

In a perfect world, you’ll want to find an account that pays an interest rate above the rate of inflation, then the real value of your money will grow, and the amount you have saved should buy you more over time.   

CPI is the inflation measure that you should aim to beat.

Moneyfacts tip

Moneyfacts tip Leanne Macardle

Sometime towards the middle of each month, the Office for National Statistics reveals the latest inflation rates and we look to see how many accounts will beat inflation.

How to inflation-proof your savings

In recent years, historically low interest rates mean savers have faced an almost impossible task to find an account that will merely maintain the purchasing power of their savings, let alone beat the rate of inflation.

Now that savings rates are on the rise, the number of accounts that offer inflation-beating rates is growing too. Whereas once these accounts were typically long-term fixed rate bonds that required locking your funds away for at least four years, now one-year bonds are also offering inflation-beating rates. 

If rates do continue their upward path, and inflation remains in check, the number of inflation-beating accounts should continue to grow.

Reviewing your savings rate regularly, and keeping a close eye on the best savings rates will give you a better chance of battling the effects of inflation.

Disclaimer: This information is intended solely to provide guidance and is not financial advice. Moneyfacts will not be liable for any loss arising from your use or reliance on this information. If you are in any doubt, Moneyfacts recommends you obtain independent financial advice.

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At a glance

  • Inflation can cause the value of money to drop over time.
  • Savers need to try and find an interest rate that at least matches the rate of inflation to maintain the purchasing power of their money.
  • Long-term bonds and one-year bonds are options when it comes to combatting the effects of inflation on savings.

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