Inflation steadily erodes the real value of your savings, shrinking your purchasing power and making it harder to achieve long-term financial goals.
As everyday costs rise, preserving wealth requires a proactive approach. Most standard savings accounts fail to outpace inflation, meaning your money loses value in real terms unless you take action.
This guide explores strategies to safeguard your capital, maintain purchasing power, and ensure your savings keep pace with an evolving economic landscape.
Potential benefits
Erodes debt value:
Fixed-rate loans become cheaper in real terms as inflation rises.
Supports wage growth:
Salaries and incomes may increase over time, offsetting some inflation.
Stimulates economic activity:
Moderate inflation encourages spending and business investment.
Things to consider
Reduces purchasing power:
The same amount of money buys fewer goods and services over time.
Can trigger higher interest rates:
Central banks may raise rates to cool inflation, increasing borrowing costs.
Savings rates lag behind:
Bank interest rates often fail to keep pace with inflation, eroding real returns.
1. What is inflation?
Inflation is the rate at which the prices of goods and services increase over time.
Rising prices reduce the purchasing power Purchasing power is the amount of goods and services that can be bought with a unit of money. When prices rise, the same £1 buys less than before. of money. For example, if a loaf of bread cost £1 last year but costs £1.03 today, £100 now has the buying power of only £97 compared with a year ago.
Some inflation is healthy because it encourages spending and investment rather than hoarding cash. However, when inflation rises too high, it erodes savings, squeezes household budgets, and makes long-term planning harder for both individuals and businesses.
OPTIMLY INSIGHT
Why some inflation is good
A moderate level of inflation — such as the Bank of England’s 2% target — helps drive economic growth by motivating people to spend and invest, which supports businesses, wages, and employment.
2. How is inflation measured?
In the UK, inflation is primarily measured using two indices — the Consumer Price Index (CPI) and the Retail Price Index (RPI). These track changes in the cost of a representative selection of goods and services, providing a benchmark for shifts in the cost of living.
Consumer Price Index (CPI)
CPI is the UK’s primary measure of inflation and the official target used by the Bank of England when setting interest rates. It calculates the average price change across a "basket" of around 700 commonly purchased goods and services — from food and clothing to energy and transport. The basket is reviewed each year by the Office for National Statistics (ONS) to reflect changing consumer habits, such as adding streaming subscriptions or removing outdated items like DVDs.
The Bank of England monitors CPI closely because it provides a clear snapshot of price trends across the economy. If CPI inflation rises above its 2% target, the Bank may increase interest rates to cool demand and bring prices down.
For example, if CPI inflation is 5%, an item that cost £100 a year ago would now cost £105. Conversely, £100 would have the buying power of just £95.24 compared to the previous year. This erosion of purchasing power highlights why stable inflation is vital for households and businesses.
Retail Price Index (RPI)
RPI is an older measure of inflation that includes housing-related costs such as mortgage interest payments and council tax. Although considered less accurate than CPI, RPI is still used for certain financial products — including index-linked government bonds, some pension schemes, and regulated price caps like train fares — due to historic contracts and legal obligations. The UK plans to phase out RPI by 2030 by aligning it with CPIH (CPI including housing costs).
3. Inflation calculator
This calculator uses UK Consumer Price Index (CPI) data to show how the value of money changes over time. It also highlights the annual savings rate you’d need to match inflation.
For more advanced features and custom date ranges, try our stand-alone inflation calculator.
Calculator
Simple inflation calculator
Enter an amount and select dates to see how inflation affects the value of money over time.
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Interpreting the result
4. Pros and cons of inflation
While inflation often feels negative, moderate levels can stimulate economic growth. However, excessive inflation — or deflation — creates significant challenges. Here’s a balanced view:
Pros
  • Encourages spending and investment by reducing the value of cash over time.
  • Lowers the real burden of fixed-rate debt, making repayments easier.
  • Supports wage growth and business revenues in a healthy economy.
  • Gives central banks room to cut interest rates during downturns.
Cons
  • Erodes the purchasing power of savings unless returns beat inflation.
  • Raises the cost of living, squeezing household budgets.
  • Creates uncertainty for businesses, making long-term planning difficult.
  • Can trigger “wage-price spirals” if inflation expectations rise too fast.
5. Dangers of too much or too little inflation
Inflation is a natural part of a healthy economy, but when it swings too high or too low, it can destabilise growth, distort savings and wages, and undermine confidence. Central banks aim for moderate inflation to balance these risks.
High inflation (above ~4%)
Rapid price rises erode the value of money and make long-term planning difficult. High inflation often triggers a “wage-price spiral,” where rising wages and costs push each other higher — a pattern seen during energy shocks or supply shortages.
  • Erodes purchasing power: – Wages and savings lose value, hitting fixed-income households hardest.
  • Uncertainty and weaker growth: – Businesses face unpredictable costs, discouraging investment and hiring. Central banks often raise interest rates to slow inflation, which can also dampen growth.
  • Risk of hyperinflation: – In extreme cases, inflation spirals out of control, as seen in Zimbabwe (2008) and Venezuela (2018), where currencies collapsed entirely.
Deflation (low or negative inflation)
Deflation — a sustained fall in prices — can be just as harmful as high inflation. It discourages spending, increases the real burden of debt, and can trap an economy in a downward spiral. For more, see our deflation guide.
  • Delayed spending: – When prices are expected to fall, consumers hold off on purchases, reducing demand and risking recession.
  • Rising real debt costs: – Falling wages and prices make debt repayments heavier, increasing defaults.
  • Lower borrowing and investment: – Businesses and households avoid loans, further weakening economic activity.
6. What is the right amount of inflation?
The "right" amount of inflation is typically considered to be moderate and steady, providing a balance between economic growth and price stability.
Central banks, like the Bank of England or the U.S. Federal Reserve, aim to maintain a target inflation rate of around 2% per year in most developed economies. This target is seen as an optimal level that encourages spending and investment without significantly eroding purchasing power.
Why 2%?
A 2% inflation rate is widely regarded as the "sweet spot" for developed economies. It strikes a balance between encouraging economic activity and maintaining price stability. At this level, inflation gently pushes consumers and businesses to spend and invest, knowing that prices will gradually rise over time. Meanwhile, it is low enough to avoid significantly reducing purchasing power, which could hurt the economy. By keeping inflation at or around 2%, central banks can foster an environment of sustainable growth while minimising the risks of both runaway inflation and deflation.
  • Encourages spending and investment: - Moderate inflation encourages people and businesses to spend or invest their money rather than hoard it, as the value of money decreases slightly over time. This fuels economic growth.
  • Reduces the risk of deflation: - Deflation, or a general decline in prices, can be harmful because it encourages people to delay purchases in the hope of lower prices in the future. A 2% inflation rate helps avoid this scenario by providing a small but steady increase in prices.
  • Wage growth: - Moderate inflation typically accompanies wage growth, ensuring that income levels keep pace with rising prices, maintaining the balance between cost of living and earnings.
  • Flexibility for Central Banks: - A small amount of inflation gives central banks room to lower interest rates to stimulate the economy during downturns. If inflation is too low or deflation occurs, central banks have less flexibility to manage economic challenges.
7. Key causes of inflation
Inflation can be triggered by several forces, often acting together. Economists group these into demand-driven, cost-driven, and expectation-driven factors.
Cause What it means Example
Demand-pull inflation When consumer demand outpaces supply, businesses raise prices to balance the market. Post-pandemic spending surge raising goods and services prices.
Cost-push inflation Higher costs for raw materials, energy, or wages push up prices across the economy. Oil price spikes leading to higher transport and goods costs.
Wage-price spiral Workers demand higher wages to match rising prices, increasing business costs and triggering further price rises. 1970s UK stagflation with strong union wage bargaining.
Monetary policy Excessive money supply growth or low interest rates can fuel demand and devalue currency. Loose central bank policies after financial crises.
External shocks Global disruptions or currency depreciation push up import costs and domestic prices. Global supply chain issues during COVID-19.
8. The inflationary spiral and economic impact
Inflation can become self-reinforcing when rising prices and wages chase each other upward — known as an inflationary spiral. If left unchecked, this cycle erodes purchasing power and can destabilise the economy.
The impact of sustained inflation is felt across all sectors of society, affecting households, businesses, and financial markets:
  • Reduced purchasing power: – Everyday goods and services become more expensive, and wages often fail to keep up.
  • Interest rate hikes: – Central banks raise rates to control inflation, making borrowing more costly.
  • Business uncertainty: – Companies face volatile costs and may delay investment or hiring.
  • Wealth redistribution: – Savers and fixed-income households lose out, while borrowers benefit as debt is eroded in real terms.
OPTIMLY INSIGHT
Why early action matters
Central banks aim to control inflation before spirals take hold, as once expectations shift, restoring stability requires stronger — and often painful — policy moves.
9. How central banks and governments control inflation
Policymakers manage inflation through a mix of monetary tools, fiscal measures, and communication strategies. Each tool can either cool the economy (when inflation is too high) or stimulate it (when inflation is too low or during recession).
Monetary policy
Central banks, like the Bank of England, adjust interest rates and control the money supply to influence how much households and businesses borrow, spend, or save. Higher interest rates make credit more expensive, slowing demand and cooling prices, while lower rates have the opposite effect and encourage spending.
Action How it works Inflation impact
Raise interest rates Higher returns on savings encourage people to save rather than spend, while borrowing (e.g., mortgages and loans) becomes more expensive. This reduces demand and slows price growth.
Cut interest rates Cheaper credit encourages borrowing and investment, while lower returns on savings push people to spend more. Increased demand raises price pressures.
Quantitative tightening By selling bonds or reducing money supply, the central bank raises long-term borrowing costs and drains liquidity, which curbs spending and slows the economy.
Quantitative easing Buying assets injects liquidity into the economy, lowering borrowing costs and boosting asset prices. This increases spending and investment.
Fiscal policy
Governments adjust taxes, public spending, and subsidies to influence demand. Higher taxes and spending cuts reduce demand and slow price growth, while tax cuts and stimulus packages do the opposite.
Fiscal Action How it works Impact on Inflation
Raise taxes Reduces disposable income for households and businesses, lowering spending and cooling demand.
Cut taxes Boosts disposable income, encouraging households and firms to spend and invest more.
Reduce public spending Government withdraws demand from the economy, slowing growth and price pressures.
Increase public spending Stimulus projects create jobs and boost demand, which can push prices higher if the economy is already at capacity.
Managing expectations
Inflation expectations influence behaviour. If businesses and consumers expect prices to rise, they often act in ways that make this happen (e.g., raising wages or prices). Clear communication by policymakers helps anchor expectations and maintain stability.
Tool How it works Impact
Forward guidance Signals future interest rate plans, shaping business and consumer spending decisions today. Stabilises
Credible inflation target Anchors price- and wage-setting behaviour by showing the bank’s commitment to a target (e.g., 2% CPI). Stabilises
Market interventions Directly intervenes in markets (e.g., currency or bonds) to prevent volatility from fuelling inflation. Stabilises
10. Impact on personal finances
Inflation reshapes household budgets and investment outcomes in subtle and sometimes unexpected ways. Its impact depends largely on your financial situation: while borrowers with fixed-rate loans may find debt becomes easier to repay, savers and those on fixed incomes often see their purchasing power erode.
Who benefits?
Not everyone loses when prices rise. Individuals or groups whose income or assets grow faster than inflation can come out ahead.
  • Borrowers with fixed-rate loans: – When inflation rises, the money you repay in the future is worth less in real terms. Your monthly payment stays the same, but its 'weight' compared to the cost of living falls, effectively reducing the real burden of the debt.
  • Property owners: – Property prices often climb during periods of inflation because land and construction costs rise. As a result, homeowners may see the real value of their property increase, boosting their overall wealth.
  • Holders of real assets: – Tangible assets such as gold, commodities, or collectables can act as inflation hedges. When prices rise, these assets typically hold their value or even appreciate, protecting owners from the declining value of cash.
Who loses?
Those relying on fixed savings or incomes are often hardest hit because inflation silently reduces what their money can buy.
  • Savers: – Standard bank accounts rarely offer interest rates that match inflation. For example, if your savings earn 2% interest but prices rise by 5%, the real value of your money falls by around 3% each year.
  • Fixed-income earners: – People whose income is not adjusted for inflation, such as retirees on a fixed pension, see their buying power shrink as everyday costs rise.
  • Consumers: – When everyday goods and services become more expensive, households may have to cut back or rely more on credit, increasing financial strain over time.
  • Import-reliant households: – Inflation often weakens the currency, pushing up the cost of imported products and foreign holidays. Families that rely on imported food, tech, or travel feel this pinch most.
Real return calculator
Even if your savings or investments grow on paper, inflation can eat away at their true value. The real return shows how much your money is growing (or shrinking) in terms of purchasing power.
Calculator
Real return calculator
Use this tool to see how inflation impacts your savings growth. A positive real return means your money is gaining purchasing power; a negative result means it is losing value even if the nominal interest rate looks high.
Enter your savings interest rate and the current inflation rate to see your real return.
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Interpreting the result
A negative result means your savings are effectively shrinking in real terms. For example, a 3% savings rate with 5% inflation reduces your purchasing power by about 2% each year.
11. How to protect your money during inflation
No two periods of inflation are the same — the economic drivers, policy responses, and global conditions can vary significantly. There is no guaranteed way to “beat” inflation without addressing its root causes. However, some asset classes have historically performed better during inflationary periods, and lessons from past events can guide your approach.
i. Diversify your savings and investments
Cash savings lose value in real terms when inflation is high. A mix of asset classes – such as equities, bonds, property, and commodities – provides better protection. Equities, in particular, tend to outpace inflation over the long term.
  • Stocks & Shares ISAs: – Over the long term, equities tend to outpace inflation. For example, the FTSE All-Share delivered an average annual real return of 5% between 1986–2020, despite several market downturns.
  • Commodities and real assets: – Assets like gold and silver often hold or increase their value during high inflation. Gold, for instance, rose 130% between 2007–2012, when inflation and financial instability were high.
ii. Consider inflation-linked savings options
Products like inflation-linked government bonds automatically adjust both interest and principal in line with inflation. UK Index-Linked Gilts and US TIPS have historically delivered stable real returns even during price spikes — particularly useful when CPI exceeds 4%.
  • Inflation-linked bonds: – The ONS reported that UK Index-Linked Gilts maintained positive real returns during 1970s stagflation, while regular gilts lost purchasing power.
  • High-interest savings accounts: – Competitive rates may not fully beat inflation but significantly slow the erosion of savings. For example, during 2022’s inflation spike, top UK savings rates reduced real losses by 2–3% annually.
  • iii. Utilise tax-efficient accounts
    Tax-efficient wrappers like ISAs protect interest or investment growth from tax. According to HMRC data (2021), using ISAs for equity investments can add 1–2% per year in net returns compared to taxable accounts — a significant difference when inflation is high.
    • Cash ISAs: – Tax-free interest means you keep more of your earnings, helping offset inflation’s erosion.
    • Lifetime ISAs: – The 25% government bonus is effectively a guaranteed uplift, which can neutralise several years of moderate inflation on your savings.
    iv. Invest in dividend-paying stocks
    Dividend growth companies often keep pace with inflation by raising payouts. A 2020 Vanguard study showed that firms with a history of dividend increases outperformed non-dividend payers by an average of 1.8% annually during inflationary decades.
    v. Consider fixed-rate investments
    Fixed-rate products work well when inflation is expected to fall. For example, locking into a 5% fixed bond in 2023 provided a positive real return by early 2025 as UK inflation fell back to 2%.
    • Fixed-rate bonds: – Predictable returns make them useful during periods of disinflation.
    • Fixed-rate cash ISAs: – Lock in rates while base interest rates are high to maintain purchasing power.
    vi. Re-evaluate your emergency fund
    Keep 3–6 months of essential expenses in cash but invest any surplus. Data from LSE’s 2021 personal finance report shows that holding excess cash during the 2010–2020 low-rate era led to an average 15% real value loss due to inflation.
    vii. Monitor central bank policies
    Central bank interest rate changes directly affect savings and mortgage costs. For example, during the UK’s 2022–2023 inflation surge, early movers who locked in fixed savings accounts outperformed standard accounts by up to 3% per year.
    viii. Explore inflation-resistant investments
    Real assets often provide a hedge as their values rise with price levels. For example, UK property prices increased by around 13% in 2021, outpacing CPI inflation of 9%. According to Nationwide’s House Price Index, UK house prices have historically risen at an average rate of 2–3% above inflation over the last 50 years, especially in periods of supply constraints and low interest rates.
    • Real estate: – Property values and rental income often keep pace with inflation. During the 1970s, when UK inflation exceeded 20%, property values rose by an average of 15–17% annually. In modern times, rental yields and rising rents have provided additional protection for investors, even when capital growth slows.
    • Consumer staples and utilities: – These sectors maintained positive earnings growth during both the 1970s stagflation and the 2022 cost-of-living crisis.
    • Commodities: – Energy and metals often spike during inflationary cycles, as seen when oil prices tripled between 2004–2008.
    • Collectibles and tangible assets: – Items like art and antiques can hold or increase value during currency devaluation.
    ix. Cryptocurrencies
    Bitcoin and other cryptocurrencies are sometimes viewed as hedges due to fixed supply, but evidence is mixed. A 2022 BIS study found their price movements are more correlated with speculative sentiment than with inflation itself.
    Conclusion
    No single asset guarantees protection from inflation, but combining equities, inflation-linked bonds, commodities, and tax-efficient savings has proven effective in maintaining long-term purchasing power.
    OPTIMLY INSIGHT
    Diversification in action
    An investor holding £10,000 split evenly between cash and UK equities from 2010–2020 saw a 35% real return after inflation, compared with just 4% for cash alone (ONS and FTSE All-Share data).
    12. Historical examples of inflation
    Inflation has shaped economies throughout history — sometimes driving growth, but in extreme cases triggering economic collapse. Examining past episodes illustrates how price rises affect savings, wages, and economic stability, and why central banks focus so closely on maintaining price control.
    Historical examples show that while moderate inflation can be managed, uncontrolled price rises — or severe deflation — can devastate economies. A combination of strong monetary policy, fiscal discipline, and diversified personal finances is essential to weather these cycles.
    Weimar Germany (1921–1923)
    Post–World War I Germany experienced hyperinflation so severe that the value of the German mark collapsed completely. Prices doubled every few days, and by late 1923, people needed wheelbarrows of banknotes to buy bread. This crisis was driven by war reparations, economic mismanagement, and uncontrolled money printing. The government eventually stabilised the economy by introducing a new currency, the Rentenmark, and implementing strict fiscal controls.
    The UK in the 1970s
    The UK experienced stagflation in the 1970s, with inflation peaking at over 20% in 1975. A combination of oil price shocks, strong union wage demands, and loose monetary policy sharply reduced purchasing power. Savers saw their deposits lose real value unless invested in high-interest accounts. The Bank of England and government eventually tamed inflation through high interest rates and austerity.
    Zimbabwe (2008)
    Zimbabwe experienced one of the worst hyperinflation events on record, with prices doubling every 24 hours at its peak. Monthly inflation hit 79.6 billion percent in November 2008, rendering the national currency practically worthless. The country abandoned its own currency in favour of foreign currencies like the US dollar.
    Argentina’s inflation crisis (2010s–2020s)
    Argentina has faced persistent high inflation for decades, with annual rates exceeding 100% in 2023. A mix of currency devaluations, fiscal deficits, and reliance on money printing eroded savings and purchasing power. Argentines often seek refuge in US dollars or tangible assets like property, as local savings accounts cannot preserve real value. This modern example shows how inflation can undermine public trust in a national currency when left unchecked.
    The UK cost-of-living crisis (2022–2023)
    Following the COVID-19 pandemic and the Russia–Ukraine conflict, UK inflation surged above 11% in October 2022 — the highest in 40 years. Rising energy prices, supply chain disruption, and food cost spikes squeezed household budgets. The Bank of England responded with aggressive rate hikes to bring inflation closer to its 2% target, illustrating the challenge of balancing inflation control with economic growth.