The inflation rate measures the increase in the prices of a representative basket of goods and services. It’s a key factor in personal finance, as it diminishes the purchasing power of the money you have. It can affect everyone, but it’s especially problematic for retirees on fixed incomes, who may not receive COLA increases to keep pace with inflation. Businesses can also struggle with rising prices, as they must pass on the cost to consumers or face lower sales.
The Office for National Statistics checks the prices of about 700 items in a “basket” of goods and services to determine if inflation is occurring. These include everyday goods like bread and bus tickets, as well as bigger-ticket items such as a car and a holiday. The price change for each item in the basket is then compared to the previous month, giving a monthly rate of inflation, and the annual rate is calculated by comparing it to the previous year.
The causes of inflation are varied, but the general consensus is that it occurs when money supply growth outpaces economic growth. The surge in inflation seen prior to the COVID-19 pandemic was due to a combination of factors, including pent-up demand, housing issues and supply chain problems. This led to double-digit inflation, but the Federal Reserve’s actions helped tame prices, and core consumer inflation has now returned to its pre-pandemic levels. Inflation is most dangerous when it’s galloping, where prices rise rapidly and the value of a currency decreases.