Money Tips

What is inflation...

Dennis
July 23, 2021
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What is inflation...

...and why should you care?

Do you feel like your money went that little bit further just a couple of years ago? No, you’re not imagining things! Your money is worth less today, than it was last year. Or the year before. It’s called inflation, and it's relentlessly chipping away at the value of your hard earned £££!

Let’s take a look at what’s happening, why it’s happening, and what you can do to beat it.


What is inflation?

Put in simple terms, inflation is the rate at which products and services are getting more expensive, which means that you’ll get less for the same amount of money. If the price of your favourite £2 burger increases to £2.10, the inflation would be 5%. Or the other way around, you’d get 5% less burger for the same money.

This applies to everything, and it happens continuously.

The official inflation rate is determined by taking a selection of day-to-day products and services from various industries (this is called a basket), and looking at the average increase across all of them. This number is usually fairly small, so it’s harder to notice. In 2020, the inflation rate for the UK was 0.85%. But since May 2021, inflation is sitting at 2.1%. And experts are warning that it might go as high as 4% this year. The reason behind this is that, as the economy opens up after the pandemic, there is more demand for products and services. With limited available supply, this increases prices. It's simply demand and supply.


How does it happen?

There are 2 main reasons for inflation: 

1. The demand for a product or service goes up, but supply stays at the same level. This causes prices to increase.

2. The rate of money created and supplied by the central bank is larger than the rate of economic growth. The more of something is available, the less it’ll be worth. This is also true for our currencies.



When would you actually want inflation?

If you own tangible assets like property or commodities, a high rate of inflation would increase the value of your assets, and therefore your profit.


Why should you care?

In an ideal world, the economic activity of a country would increase everybody's wealth. And people's incomes would increase at or above the rate of inflation. Unfortunately, this isn’t the case for the majority. In fact, younger generations are actually earning comparably less than previous ones, even though they might be earning more on paper. Inflation outpaced salary increases, and the buying power of the currency has been reduced.

Likewise, if you have cash sitting around in a current or savings account, inflation will continuously eat away at its value, as bank interest is usually less than the inflation rate.

Inflation is also sometimes called a hidden tax, as the government benefits from the decreased purchasing power.


What can you do?

If you have a job and have been on the same salary for a long time, try to negotiate a salary increase, which should be at least at the rate of inflation.

And if you have savings, invest them into low risk assets, like an Exchange Traded Fund. These grow at around 7-10% per year on average, and will therefore easily beat inflation rates.

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