What is inflation and what is the current rate?

INFLATION has risen above the Bank of England’s 2% target according to the latest data from the Office for National Statistics (ONS).

It soared to 2.5% in June – higher than the 2.2% rate that economists had predicted it to be.

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But what actually is inflation? And how does it affect prices and the economy? Here’s what you need to know.

What is inflation? And what does it mean?

Inflation is a measure of how much the price of goods, such as food or televisions, and services, such as haircuts or train tickets, has changed over time.

The rate of inflation is published each month by the Office for National Statistics (ONS), and this measures how much prices have changed on average over the past year.

For example, the latest publication looked at prices for the year to June 2021 compared to prices for the year to June 2020.

It reported that inflation rates rose sharply since the UK government began a phased lifting of coronavirus restrictions from March.

So if a loaf of bread cost £1 a year ago and inflation is now at 2.5%, then the price of that loaf of bread would now be around £1.03 as it has risen by 2.5%.

How is inflation measured?

Inflation is measured by the ONS, which collects around 180,000 prices of about 700 goods and services used across the country.

These prices are updated every month with officials visiting the same retailers each time to ensure consistency.

The prices are then weighted with more prominence being given to products people buy more often, such as fuel rather than postage stamps, for example.

There are numerous different measures of inflation that all track slightly different baskets of goods. The main measure is known as the Consumer Prices Index (CPI), and state benefits and the state pension also rise inline with it.

There is also a Consumer Prices Index including housing costs (CPIH) measure, as well as a Retail Prices Index (RPI) measure, which is used to calculate annual rail increases and student loan interest rates among other things.

What is the UK’s current inflation rate?

The CPI measure of inflation jumped to 2.5% in June 2021, the latest figures available.

The surge in clothes, food, fuel and eating out prices was driven by Covid rules being eased in previous months.

Hikes came as Brits could go out and spend money in shops, boozers and restaurants once more.

Inflation plummeted because of the coronavirus pandemic but is now rising again as the country reopens and the economy gets back on track.

What impact does inflation have on prices and the economy?

Inflation matters because it affects the value of wages, savings and more. As such, the Bank of England has a target inflation rate of 2%.

This target is set by the government which believes a small amount of inflation at a stable level is good, because it boosts economic output by encouraging spending, which in turn means businesses can afford to generate employment opportunities.

It can also make goods more attractive to foreign buyers as it can make their currency worth more, comparatively, to another countries.

Conversely, if inflation is too high or it goes up and down a lot, it can be hard for businesses to set the right prices and for people to plan their spending.

It can also mean the cost of essential goods and services can suddenly outstrip the buying power of people’s wages.

At the other end of the scale, if inflation is too low, or negative, then some people may put off spending because they expect prices to fall further.

Low inflation is, however, good news for savers as the interest paid on savings is more than the increase in the cost of goods meaning your spending power is going further.

For example, at present, the top easy-access current account is 0.5%, according to Moneyfacts, which is less than inflation at 2.5%.

The Bank of England also uses inflation as a guide when it is setting the base rate. The base rate is currently set at a record low of 0.1%.

It dropped from 0.25% to 0.1% in March 2020 to help control the impact of coronavirus on the economy.

Banks then use this base rate to set rates on everything from personal loans to mortgages.

A low base rate means bank interest rates are also likely to be low, which is good for borrowers.

Variable rate and tracker mortgages follow the base-rate and can go up or down at any time – so you’ll also likely pay less if inflation goes down.

But low inflation can mean banks slash interest rates on savings too, so you’ll be earning less on your money.

Low inflation can also mean your debts get more expensive, as the amount you owe remains the same, yet you may find it harder to repay debts or the item, such as house or car, may depreciate in value compared to its initial worth.

See our guide on is Is low inflation good or bad? for more information.

What is deflation?

Deflation – or negative inflation – is when the rate of inflation falls below zero.

This can happen when the supply of goods is higher than the overall level of demand. It can also be triggered by lower production costs, or a shortage of money in circulation.

The UK was last in deflation territory in 2015, and though some experts speculated we could see negative inflation as a result of coronavirus pressures on the economy, the latest rise in inflation makes this less likely.

This would mean lower prices for consumers, which on the surface is a good a thing.

But the Bank of England points out that when prices fall, people often don’t make purchases as they hope costs will fall further.

And when people stop buying, less money is going to businesses and into the economy, and in turn those businesses may cut wages or make job losses.

How can I protect my finances against rising inflation?

The best way to beat the price hikes as inflation soars is to check your finances and see where you can cut costs.

You could save up to £200 a month by switching to cheaper supermarkets like this savvy saving single mum did.

And using comparison websites like Uswitch or Compare the Market could help you switch energy providers to save hundreds of pounds each year.

Cutting subscriptions like your Netflix and Spotify account and quitting the gym could save you £1,200 a year.

While making the most of yellow sticker aisles in supermarkets could shave over 50% off your food bill.

For more guides, we’ve rounded up eight Martin Lewis money-saving tips that could save you £9,243.

Here is a mammoth 50 ways to save money including best apps.

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This post first appeared on thesun.co.uk