What does high inflation mean for me? Current 2021 UK rate and why interest rates are expected to rise in 2022

Inflation vs interest rates explored as calls intensify for the Bank of England to intervene

Inflation has increased to a 10-year high in the UK, according to the latest figures published by the Office for National Statistics (ONS). (Pic: Shutterstock)

Inflation has increased to a 10-year high in the UK, according to the latest figures published by the Office for National Statistics (ONS).

The Consumer Price Index (CPI) shows that the cost of living has risen for the third month in a row to 4.2% - its highest levels since November 2011.

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October 2021’s inflation figure is an increase on September’s rate of 3.1% and has been attributed to the rising cost of fuel and energy shouldered by households.

It has served to intensify calls for the Bank of England (BoE) to increase interest rates to bring a seemingly spiralling inflation under control once more before the end of the year.

Here’s all you need to know about what high inflation means, why it is currently so high, BoE’s 2022 forecast and inflation’s relationship with interest rates...

What does high inflation mean?

The rate of inflation is used to measure the current cost of living.

It takes into account the current price of goods and services, including fuel, energy bills, food, clothes and even things like the cost of second hand cars.

When the cost of basic goods and services is up, as is the case at the moment, then households get less for their money, meaning the value of the pound has depreciated.

In real terms, it means that the £10 note in your pocket doesn’t stretch as far, which sees consumers reducing the volume of purchases or using more money to get what they need.

Why is inflation so high at the moment?

Inflation is a variable which can go down as well as up.

During the 2020 lockdowns brought on by the Covid pandemic, inflation was low as people couldn’t get out and spend their money.

But as society began to open up again and businesses opened doors once more there was, and continues to be, a pent up demand for goods and services.

This demand, coupled with a consistent, or in some instances a reduction of, supply incentivised businesses to shift prices up, stimulating the economy.

A growing economy has increased employment rates, pumping more money into circulation and in turn demonstrating a healthy economy, as financial markets recover from Covid restrictions.

How high could inflation go in the UK?

The inflation rate recorded for October 2021 was driven by the increasing costs of fuel and energy, with the energy price cap hike.

Wholesale gas prices had seen many energy companies shoulder the financial strain in the short term, with more than 20 already ceasing to trade.

Due to the rise in inflation, there have been calls for the BoE to increase interest rates to rein in demand and bring more of a balance to the economy.

Why do interest rates rise with inflation?

There is often a correlation between interest and inflation rates.

One is used to alter the other depending on the current state of the economy and outside factors, such as a global pandemic.

Where inflation rates are used to measure the cost of living, the interest rate is the amount charged by the lender to the borrower.

Low interest rates means it’s essentially cheaper to borrow money from lenders, with the BoE cutting interest rates to an all time low of 0.1% in March 2020.

This extreme action was brought on by the Covid pandemic and, while the rate has stayed at 0.1% since, there are increasing calls for the BoE to increase interest rates.

The low interest rate was implemented to encourage people to spend money during lockdowns and restrictions brought on by the Covid pandemic, rather than save or keep it in savings.

Generally, lower interest rates means people spend more money, leading to economic growth with higher prices and higher employment rates as businesses keep up with demand.

This can also work the other way around, when there is an ‘overheating economy’.

High interest rates make it more appealing to save money, leading to a slower economic growth by dropping prices of goods and services, which can lead to higher unemployment rates.

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