Price hikes in the economy have fallen to their lowest level in 30-months. But what is inflation?
The Office for National Statistics (ONS) calculated that the rate for March, the most recent month for which we have data, fell to 3.2%. This is significantly below the inflationary peak we saw in October 2022, when inflation hit 11.1%.
The latest figures have come partly as a result of the highest interest rates the UK has seen for 16 years. But they are also thanks to how inflation is calculated, with the country's headline rate being the Consumer Prices Index (CPI).
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So, what is inflation - and how does it affect you? Here's what you need to know.
What is inflation?
Inflation is a measure of how quickly prices are rising over a given time period. Put simply, if you spent £1 on a product this time last year and inflation now stands at 10%, that same product is likely to now cost £1.10.
So, it's 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 some key utility bills go up by, as well as how much people can get from the state pension.
Economists believe having some inflation (2% in the UK) is healthy for the economy because it encourages spending and means GDP can grow. But having too much or too little can weaken the economy, while soaring inflation can do severe damage to living standards (as we've seen during the cost of living crisis). Deflation, i.e. the rate of decreases in prices, is seen as being even worse than inflation.
Every month, the Office for National Statistics checks the prices of hundreds of goods and services in an imaginary shopping basket. This is meant to represent the sorts of things that the average British consumer buys - although it is by no means a perfect science.
It includes supermarket basics like bread, milk and fruit, as well as electrical products, clothes, energy bills, flights, train tickets and accommodation. It also gets updated every year to reflect changes in UK spending habits.
Inflation is expressed as several different indices, but the most widely reported is the Consumer Prices Index (CPI). The CPI is an internationally-recognised measure of inflation.
It strips out housing costs like council tax and mortgage payments. Other indices include the Retail Prices Index (RPI) and Consumer Prices Index including owner occupiers' housing costs (CPIH).
Will inflation continue to fall this year?
The Bank of England says its first priority is to keep inflation at 2%. As of March, it sat at 3.2%. Forecasters expect inflation could fall rapidly this year. The Oxford Economics consultancy and analysts at Investec and Deutsche Bank have predicted that CPI will drop below 2% within a few months, while ING Group goes further, expecting the rate to plunge to 1.5% in May.
Next month, we are likely to see a dip in the rate given energy bills fell 12.3% on 1 April. Energy bills were one of the key reasons why inflation soared so high in the first place.
Looking further ahead, the Office for Budget Responsibility (OBR) reckons we could see inflation below 2% for much of 2025. In its report accompanying the Spring Budget, it said inflation had “receded more quickly” than expected since its Autumn Statement calculations. It says its central forecast now has CPI inflation dropping to an average of 2.2% over the course of 2024, and 1.5% over the duration of 2025, before it climbs back towards the Bank of England’s 2% target.
However, the OBR also highlighted the risk of an escalation in the Middle East in its forecasts. Although it expects the Red Sea crisis to cause a small 0.2 percentage point upward movement in inflation, a wider conflict could see the headline rate climb back towards 6%. This would be mostly due to an expected surge in wholesale energy prices.
Another fly in the ointment is wage growth. While pay rises are a good thing for our wallets, the Bank of England fears they can fuel inflation as they may boost people's spending power. According to the most recent wage data, wages grew 2.1% in real-terms once the CPI was taken into account.
The Bank of England has itself said that inflation could drop to 2% in the spring “for a short while”, though is likely to increase after that. It has repeatedly raised interest rates over the past 18 months to try and tackle stubbornly high inflation. The base rate is now at 5.25% - a 16-year high - and may stay at this rate for a bit longer given inflation is proving to be sticky.
How does inflation affect you?
Inflation affects different people in different ways, and some people will have a higher rate of personal inflation than others depending on their wealth. For example, a 75-year-old person reliant on the state pension is likely to spend a greater proportion of their income on heating and food compared to a 40-year-old high flyer on a City income.
But no matter who you are, price hikes will affect your budget, and may potentially reduce the number of things you can afford.
Inflation is also used by the government and businesses to set prices. Things like train fares and broadband go up in price every year depending on the inflation rate, so that - in theory at least - they don't lose out from the erosion of the value of the pound.
This can also work to your advantage. It's worth bearing the rate of inflation in mind when considering asking for a pay-rise, or if you're a landlord and want to increase rents.
If you want to ensure the value of your money keeps up with - or at least stays close to - inflation, we've listed the inflation-busting savings accounts currently on offer. However, you may need to be quick as banks and building societies could soon start to further reduce their rates in anticipation of a Bank rate cut later this year.
Check out our round-up of the best easy-access accounts, one-year savings bonds, regular saver accounts and cash ISAs.
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