What is inflation and how does it affect you?

Inflation is a key economic metric that affects the cost of living, interest rates and determines the value of your money.

In simple terms, inflation measures how much the price of goods and services is rising over a set period of time.

The Office for National Statistics (ONS) tracks inflation across different baskets of goods – the main one is the Consumer Price Index (CPI).

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Inflation is keenly watched by the government and Bank of England as it has a significant impact on consumers and the public finances.

When inflation is rising, it means people are having to pay out more than they were before for the same product or service, eroding the real-terms value of their money if wages aren’t growing at the same rate.

The most recent set of inflation data shows the CPI measure rose by 3.3% in the 12 months to March 2026, up from 3% in February 2026.

The March dataset is the first which reflects rising prices caused by conflict in the Middle East.

Oil prices have surged since the US-Israeli attacks on Iran on 28 February, and UK energy prices are expected to rise by 12% in July when the new Ofgem price cap comes into effect, due to the conflict.

Rising inflation doesn’t just mean higher prices of everyday goods, it can impact the mortgage and savings market too.

We take a closer look at what inflation is, how it is measured, and what it means for your finances.

What is inflation and why is it important?

Inflation is a measure of how much prices have risen over a given time period. If you bought an apple for £1 in one year, but bought the same apple for £1.10 the next year, its price will have inflated by 10%.

That said, the rise in price of one item doesn’t reflect how much prices are increasing across an entire economy.

The apple’s price may have increased at a much faster rate than other services or products. For example, a poor harvest leading to fewer apples than usual could prompt a price rise due to the laws of supply and demand.

Furthermore, different people buy different things. You might be more likely to buy a packet of sweets than an apple, meaning you are less affected by the rising price of apples.

When the ONS tracks inflation, it looks at a wider basket of goods and services rather than just one item.

Depending on which basket you’re looking at, it will include price rises of food, energy, clothes, hotels, train tickets and more.

The ONS shakes up its basket of goods once per year to accurately reflect consumer trends. This means the statistics body is getting a more holistic view of how prices are changing across the entire economy.

Once the ONS has gathered all the prices, it calculates the level of inflation in the economy and expresses it through several different indices. The most widely reported is the Consumer Prices Index (CPI), which is the most internationally-comparable index.

CPI strips out housing costs like council tax and rent payments. Other indices include these, such as the Retail Prices Index (RPI) and the Consumer Prices Index including Owner Occupiers' Housing Costs (CPIH).

Measuring inflation is a useful way of measuring how our spending power has changed over time, but it also has a real-world impact.

For example, inflation rates are used to set the amount by which rail fares, some key utility bills and even interest rates on student loans go up. The figure is also sometimes used to decipher how much the state pension will rise by, under the triple lock mechanism.

Economists believe having some inflation (for example the Bank of England's 2% target, which is set by the government) is healthy for the economy because it encourages spending and means GDP can grow.

However, high inflation can do severe damage to living standards, as we saw during the cost of living crisis.

Why will there be inflation in an economy?

There are a whole host of reasons why prices rise in an economy.

Food prices can be pushed higher because of natural causes, like bad weather, which can affect crop yields and lead to product shortages.

Prices can also be artificially inflated through government actions. In the United States last year, prices of some foreign goods increased after Donald Trump imposed a sweeping set of tariffs (taxes paid to the government when importing goods).

On the whole, there are two main types of inflation – ‘cost-push’ and ‘demand pull’.

• Cost-push inflation: This type of inflation is caused by an increase in production costs. Imagine cocoa prices rise. This might make it more expensive for a chocolate company to produce chocolate bars. In response, the company can either produce fewer bars or put up its prices. In recent years, companies have circumvented higher production costs by shrinking the size of products but keeping the price the same, known as ‘shrinkflation’.
• Demand-pull inflation: This type of inflation happens when demand outstrips supply. A good example is what happened after the Covid lockdowns ended. Households had saved up a lot of money while they were cooped up, and splurged after the economy opened back up.

Inflation expectations can also create price pressures.

If workers think what they will pay for products will rise, they might negotiate larger pay rises from their employers. This pushes up costs for businesses by giving them a higher wage bill.

It also gives workers more money in their pocket, making them more likely to spend. Both effects can worsen the inflation cycle.

How does inflation affect you?

Inflation affects different individuals and groups to different extents. Some people will have a much higher personal inflation rate than others depending on the types of things they spend money on.

For example, someone who travels to and from work everyday by car is much more likely to be stung by rising fuel prices than someone who commutes.

Meanwhile, a family of four will be more greatly affected by a rise in food prices than a single person living by themselves.

Inflation is also used by the government and businesses to set prices and make sure revenues do not fall in real terms.

For example, train fares have historically gone up in price every year depending on July's inflation rate, though the government has frozen fares in 2026 for the first time in 30 years.

Fare hikes, in theory at least, mean services like the railways don't lose out from the erosion of the value of the pound.

Inflation can also work to your advantage. It's worth bearing the rate of inflation in mind when asking for a pay rise, or if you are a landlord and want to increase rents.

When it comes to your personal finances, you need to make sure the value of your money keeps up with or at least stays close to inflation. To achieve this, you will need to put your money into an inflation-busting savings account or consider investing money (once you have built up an emergency savings pot).

See our round-up of the best easy-access accounts, one-year savings bonds, regular saver accounts and cash ISAs.

Once you have built up sufficient cash savings, you may also want to consider investing, provided you are willing to lock the money away for at least five years to ride out short-term market volatility. Investing in a diversified portfolio of assets can be a good strategy for beating inflation.

Research by data firm Moneyfacts reveals the average stocks and shares ISA fund experienced growth of 11.22% in the year to February 2026, compared to the average cash ISA which returned 3.48% over the same period.

We take a closer look at this topic in our beginner’s guide to investing, and in our piece on saving versus investing.

What is the Bank of England's role in controlling inflation?

The Bank of England, as the UK’s central bank, plays a key role in keeping inflation in check. The main way it does this is through adjusting the “bank rate”.

The bank rate is the rate of interest the BoE pays to commercial banks, building societies and other financial institutions that hold money with it. It is also the rate the BoE charges on loans to them.

That is why a change in bank rate usually leads to changing interest rates for everyday consumers.

A hike in interest rates can incentivise saving and increase the cost of borrowing, which is a disinflationary pressure, and a cut can incentivise more spending and make borrowing cheaper, an inflationary pressure.

The BoE can also stimulate inflation through quantitative easing (QE), when it can’t lower the bank rate anymore. QE was most famously used in the UK during the 2008 financial crisis.

This process involves buying bonds to push up their price. This leads to interest rates falling, encouraging people to spend money.

The BoE can also sell bonds through quantitative tightening (QT), to reduce money supply in the economy and slow inflation.

What is the difference between disinflation and deflation?

Disinflation and deflation are two different things, and understanding the difference between them is important.

Disinflation is when the rate of inflation slows but prices are still rising, just at a slower pace than previously.

For example, if inflation one month reads 3.4% then drops down to 3% the following month, there has been disinflation of 0.4 percentage points.

Deflation, sometimes known as negative inflation, refers to when the rate of inflation falls below zero, meaning prices are falling. Economists believe deflation is worse than inflation as it can lead to consumers holding off from spending in the hopes the price of something will fall in the future, causing an economy to slow.

Deflation can also make debts more challenging to pay off, as the real value of the debt goes up. In turn, this can result in recession and higher unemployment rates as companies lay off staff.

A classic example of this can be seen in the US Great Depression of 1929 to 1933, when prices fell by a third. Businesses that took on high levels of debt during the 1920s found they were no longer able to pay back their creditors, which led to a wave of repositions and bankruptcies, throwing millions out of work.

What is stagflation?

During the rise in inflation in 2025, some commentators claimed the UK was at risk of falling into a stagflationary state as GDP growth was minimal while prices kept rising.

Fundamentally, stagflation is a situation where economic growth is stagnant or falling while inflation is high. By some definitions, if unemployment is high, this also adds to a stagflationary scenario.

The resulting economic situation becomes challenging, as high inflation means the purchasing power of money is eroded while slow or non-existent economic growth and high unemployment mean people have less cash to spend.

The UK experienced a long run of stagflation in the 1970s when inflation reached 24.5% in August 1975. At the same time, the economy was contracting – GDP fell by 2.5% in 1974 and 1.5% in 1975.

We take a closer look at whether the UK economy is heading for stagflation due to the conflict in the Middle East.