Inflation and your money

Inflation is the quiet tax on cash. Prices rise every year, so the same £100 buys a little less than it did twelve months ago — and compounding means the effect grows. Understanding it is the difference between a savings balance that looks healthy and one that’s actually shrinking.

How it works

Inflation is a rise in the general level of prices, usually measured by CPI. If inflation is 3%, a £1,000 shop that cost you today will cost about £1,344 in ten years’ time. Your money isn’t stolen from your account — it’s just that your account buys less each year.

The real return

Every savings decision comes down to the real return:

Real return = your interest rate − inflation

Earn 4% while inflation runs at 3% and your real return is 1%. Earn 2% while inflation is 3% and you’re losing 1% of buying power a year. A savings account can pay you interest and still make you poorer in real terms.

Example. £1,000 in the bank at 3% inflation. In ten years’ time the balance has grown on paper — but in today’s money it’s worth about £744. You need an interest rate at or above inflation just to stand still.

Why it compounds

Inflation applies to already-inflated prices, so the damage builds year on year. The longer money sits, the more of its purchasing power inflation eats — the mirror image of compound interest on your savings.

What to do about it

1. Short-term money (emergency fund, near goals) — keep in easy-access cash or a cash ISA. Beating inflation matters less than safety and access.
2. Long-term money (retirement, 10+ years away) — a stocks & shares ISA has historically outpaced inflation over long periods, though it can fall short in any single year.
3. Pay rises — a 3% pay rise with 4% inflation is a real-terms pay cut. Always judge salary offers against inflation.

See the maths

Use the inflation calculator to see what prices will cost and what your money will be worth, and the savings calculator to check whether your rate is keeping up.