Have you ever wondered why you are paying more for your grocery shopping than you did a year ago? This is because of inflation. Inflation is a measure of goods and services such as food or fuel that have gone up overtime. Use this inflation calculator to see just how much prices have gone up over the years.
Inflation is measured monthly by the Office for National Statistics (ONS). They collect around 180,000 prices of approximately 700 items and then use this shopping basket of goods to work out the Consumer Price Index (CPI). CPI is the measure of inflation.
The government sets the Bank of England a 2% inflation target which means prices are targeted to be 2% higher (on average) than they were a year ago. The reason the government sets a 2% target is to keep inflation low and stable which helps everyone plan for the future. High inflation may lead to a fall in real income as businesses may be forced to raise their prices, whereas low inflation is usually associated with a weak economy which normally leads to unemployment as there is a lower demand for goods and services.
It is rare that inflation is at 2% although it is usually close to the target rate (currently 2.4%). If the Bank of England miss the inflation target by 1% either side i.e. less than 1% or more than 3%, their Governor must write a letter to the Chancellor explaining why this is and what they are going to do in order to achieve the 2% target.
Inflation can also have an impact on your investments. For example if you have £1,000 in the bank earning 0.5% interest, the real return (the return an investor receives after the rate of inflation is taken into account) on your investment is actually -1.5%, assuming inflation was in line with its 2% target.
Of course, the returns you receive are dependent on the amount of risk you are willing to take but the real return is a very important factor to take into consideration when investing because if you are not careful inflation will significantly erode your capital value over a period of time. Should you wish to talk to someone about making your cash work harder and potentially generating higher returns through investment markets and asset backed investments, contact us today.