Inflation and interest rates can significantly impact your everyday spending, as you’re probably experiencing first-hand!
Mortgage costs, credit card interest rates, and other borrowing costs can grow when interest rates go up. Our expenditure also grows when inflation rises, thanks to increasing energy, fuel and food prices.
In the UK, the public has experienced a tremendous increase in living costs, with inflation sitting at 9.1%, its highest in 40 years.
Inflation describes the rate at which everyday prices are rising. It’s also used to demonstrate how much prices have increased over long periods, with economists able to compare prices from the past with prices today.
Interest rates and inflation rates often increase simultaneously, with interest rate increases intended to lower the impacts of high inflation.
Recently, the Bank of England raised interest rates to 1.25% to try and reduce the impact of fast-growing inflation.
The idea behind increasing interest rates is that it makes borrowing money more expensive and encourages people to save, therefore curbing demand and, theoretically at least, cooling prices.
Historically, higher interest rates mean people tend to be more mindful of their spending habits. When people are more aware of what they spend, businesses need to find ways of encouraging them to do. When this manifests as lower prices, inflation slows and sometimes even leads to price deflation.
If certain products are in high demand, however, prices usually increase. Interest rates have been at record lows for years, even before the Covid-19 pandemic. The desire of people to start spending post-pandemic and relatively cheap borrowing, aligned with global economic conditions and the situation in Ukraine, has enabled inflation to increase significantly.
While increasing interest rates can help curb rising inflation, it also puts pressure on those with significant debts, whether those are held on a credit card or in the form of a mortgage.
Homeowners with mortgages, for example, may have noticed their monthly payments increase, especially if they are on typical tracker mortgage agreements. Anyone with fixed-rate agreements will not feel the effects of rising interest rates immediately but are almost certainly going to see an increase when they’re shopping around after their fixed-term ends.
Interest and inflation rates also affect pensions and savings. Inflation affects pensions because, fundamentally, the value of cash decreases when inflation rises. Therefore, people may be adding more money to their pensions, but their funds will decrease in value in the face of high inflation if their investment doesn’t keep up.
An increase in interest rates can be a positive for those with savings, as they get more of a return from the bank. Although this sounds good, the interest rates offered by the banks will not be enough to keep up with rising inflation rates, if they pass higher rates on at all.