What is the UK inflation rate and why does it matter?

Why is the cost of living rising? The UK inflation rate and what it means for you explained

Upward-pointing arrow on a blackboard with wooden blocks spelling inflation
(Image credit: Getty images)

The UK inflation rate has hit 10.1% - up from 9.4% in June. But what is inflation and what does it mean for the pounds in your pocket? 

In simple terms inflation is the rate at which prices are going up. It includes everything from the price of food on the supermarket shelves to soaring energy bills and how much we pay at the pump for petrol and diesel.  

When inflation is low, and the Bank of England (opens in new tab) has a target of 2% for inflation, we may barely notice any change in prices.

When inflation is high, costs can go up and you can quickly notice you’re getting less for your money. 

For example, if the annual rate of inflation is 10% a loaf of bread that typically cost £1 a year ago could now set you back £1.10. These price hikes all add up, leading to a higher cost of living

Here we explain how inflation is calculated, how it can be used to hike prices and what you can do about it.

How is inflation calculated?

The Office for National Statistics (opens in new tab) (ONS) is responsible for crunching the numbers and coming up with the UK inflation rate.

Each month it checks the prices of around 700 goods and services typically bought by the averageUK  household – checking prices in various stores in different locations across the country and online.

The ONS then works out if we’re paying more than we did at the same time last year – arriving at the current inflation figure which is called the Consumer Prices Index (CPI).

The contents of the basket of goods gets an update once a year to reflect changes in our buying habits. Last time - mens’ suits and doughnuts were left out whereas meat free sausages and anti bacterial wipes were added to reflect our ever-changing shopping habits. 

But to make things complicated there’s not one single measure of inflation. 

There’s also another older index - the Retail Prices Index (RPI). It’s usually higher than CPI and it’s used to increase prices on things like train fares, mobile bills and the interest you pay on your student loan.

Personal finance analyst with Hargreaves Lansdown (opens in new tab), Sarah Coles said: “CPI and RPI are different, partly because they include different prices in their calculations – most notably CPI doesn’t include any housing costs. Generally CPI tends to be lower than RPI. CPI is currently 10.1% and RPI is 12.3%”.

Which inflation rate is used for what?

While the UK inflation rate reflects the price of pretty much everything we buy – it also affects increases in benefits and pensions.

When it comes to the Government giving you money - any increase in benefit payments is pegged to the lower CPI figure and applied to payments including Universal Credit, Jobseeker’s Allowance, Income Support, state pension and statutory sick pay.

But according to Sarah Coles: “RPI is used for all sorts of things we have to pay to the government – like car tax and duty on alcohol and tobacco. It has been accused of inflation shopping – where it chooses the inflation rate that will leave it better off”.  

With train tickets – any rise in rail fares is usually pegged to the July RPI rate  plus 1%. With the higher RPI rate used - this would have meant a hefty rise of 13.3% next March when rail fares are due to go up.  

But the Government has promised any increase will be lower than the rate of inflation – but we don't know how much this will be.

If you live in a shared ownership property - it’s the RPI figure that’s usually used when working out any annual rent rise. Under Government rules most landlords are limited to charging the RPI figure plus 0.5%.

And when it comes to your mobile and broadband  bills – any annual increase is usually pegged to the RPI figure plus an additional amount of around 2-3 % but may be as high as 3.9% in some cases as with Virgin Mobile and O2.

How does inflation affect your savings?

Many of us have resorted to dipping into our savings to cope with the cost of living crisis and one in five of us have less than £100 in savings according to Yorkshire Building Society (opens in new tab).  Even if you’re fortunate enough to have some cash stashed away, inflation is eating away at its buying power.

Finance Expert at Moneyfacts (opens in new tab), Rachel Springall, said: “Savers will see more positive change across variable and fixed rates since the last inflation announcement. However, the stark reality is that not one standard savings account can currently beat inflation. 

“Savers must not become apathetic as they could miss out on a lucrative rate, so even if cash is being eroded in real terms, savers can at least secure a higher interest rate to mitigate its impact. 

“Challenger banks continue to jostle for table-topping positions to entice savers’ deposits, so it’s wise to keep a close eye on the moving market”.

The best easy access savings accounts on the market currently pay 1.8%, and the best five year fixed rate – 3.5%.

Sue Hayward

Sue Hayward is a personal finance and consumer journalist, broadcaster and author who regularly chats on TV and Radio on ways to get more power for your pound.  Sue’s written for a wide range of publications including the Guardian, i Paper, Good Housekeeping, Lovemoney and My Weekly. Cats, cheese and travel are Sue’s passions away from her desk!