Skip to content

What does inflation mean for your savings?

Inflation rates are often in the news – going up or down, a sign of good times or bad for the economy. But what do these changes mean for you and how will they affect your savings? Let’s take a look…

Inflation rates are often in the news – going up or down, a sign of good times or bad for the economy. But what do these changes mean for you and how will they affect your savings? Let’s take a look…

Written by
Sajni Shah
Consumer expert on money and utilities
Last Updated
5 APRIL 2023
7 min read
Share article

What is inflation?

Inflation is a measure of how much the prices of goods and services change over time. It’s usually calculated by comparing the cost of things today with how much they were last year. The average increase or decrease in prices is the rate of inflation. If there’s a percentage increase in inflation, it means your money won’t go as far.

For example, if inflation was at 4%, it would mean prices were 4% higher, on average, than the previous year. Something that used to cost £100 would now cost £104.

Over the decades, these differences can add up. Thirty years ago, penny sweets really cost a penny and a round of drinks was less than £5. Times change, and money changes with them.

How is inflation measured?

Every month, the Office for National Statistics (ONS) produces three measurements of inflation:

  • The Consumer Prices Index (CPI) This is the most commonly quoted figure and is created by checking the prices for around 700 items that consumers commonly spend money on. They include bread, chicken, cinema tickets, furniture and alcohol.

    The items that make up the CPI are collectively referred to as the ‘consumer price inflation basket of goods and services’. It’s designed to reflect what we, as a nation, regularly spend our money on. The items in the basket are reviewed every year to make sure that what’s being measured still reflects accurate patterns of consumer spending.

  • The Consumer Prices Index including owner-occupier’s housing costs (CPIH) Adds to the CPI by including costs associated with living in your own home, like council tax.

  • The Retail Prices Index (RPI) An older measure of inflation that’s not used for statistical purposes. Plans are afoot to reform it.

What’s inflation used for?

Inflation is one of the main factors considered by the Bank of England when it sets the base interest rate, also known as the Bank Rate or base rate. This influences the amount of interest that banks will pay you on your savings, as well as how much they’ll charge in interest if you want to borrow money.

If the base rate is reduced, it could mean that you don’t earn as much interest on your savings, although getting a loan or a mortgage might be easier. If it’s increased, the opposite may be true.

What does inflation mean for your savings?

Say you put £100 aside. A year later, if inflation is going up, that money can’t buy quite as much as it used to. But hopefully, if you put that money in the right kind of bank account, you earned some interest over the course of that year. The question is, have you lost or gained overall?

If inflation is at 1%, but you earned 2% interest, that’s great – you came out on top. If inflation is at 2% and you only earned 1% interest, you made a loss in real terms over the year, as your money will buy you less than at the start of the year.

The key point is that if you want your money to grow, make sure the interest rate you get on your savings account is higher than the rate of inflation.

How can you get an interest rate that keeps up with inflation?

When the economy is in a downturn, it can be hard to get good interest rates for your savings. Inflation is often low – but so are interest rates – making it hard, but not impossible, to stay ahead of inflation. Here are a few options you can look into:

  • fixed-rate savings account - also called fixed-term deposits or fixed-rate savings bonds, these accounts lock your money away, usually for 1 to 5 years. In exchange, you get a higher rate of interest than a typical savings account and this will stay the same for the entire time that your money’s in the account. It means you know exactly how much you’ll earn. 
  • cash ISA - these are a great option if you’re looking to minimise the tax you pay. Any interest you earn on your ISA is tax-free. You can pay in up to your ISA limit each year – a maximum of £20,000 in 2021-2022. If you choose an easy-access cash ISA, you can take your money out whenever you like without paying a penalty.
  • fixed-rate ISA - combining the tax benefits of an ISA with the features of a fixed-rate savings account, fixed-rate ISAs lock your money away for a set term and generally offer a better rate of interest than a cash ISA. 
  • stocks and shares ISA - also known as an investment ISA, this is a medium to long-term commitment, so could be right for you if you’re happy to put your money away for at least five years. Pick your own funds and shares or opt for a ready-made portfolio, but remember there are no guarantees. The value of your savings can go down as well as up. Annual charges and service fees may apply. (You can’t compare this type of ISA with us.)
  • innovative finance ISA (IFISA) - involves investing in peer-to-peer (P2P) lending. When you put your money into an IFISA, you become a lender. You’ll get a higher interest rate than with other ISAs, but your money isn’t protected by the Financial Services Compensation Scheme (FSCS), so give it careful consideration to make sure the risk is worth the potential rewards.
  • lifetime ISA - designed to help you save for retirement or to buy your first home. You can pay in up to £4,000 a year until you’re 50 and the Government will add an extra 25% – so you get up to £1,000 of free money. The downside is that you can only take the money out when you buy your first home, when you retire at 60+ or if you’re terminally ill with less than a year to live, otherwise you lose all your bonuses. You must also make your first payment before you’re 40.

Always read the small print carefully before you make any decisions about where to put your money. And if you get an offer of a savings account out of the blue via a call, email, post or word of mouth that sounds too good to be true, it could be a scam, so be very wary.

Compare savings accounts

Ready to hunt down that inflation-busting interest rate? We help you compare rates for a wide range of savings accounts, cash ISAs and fixed-rate ISAs

Frequently asked questions

Why do inflation rates change?

Inflation tends to fluctuate, depending on whether people feel like spending their money. If everyone is spending, inflation tends to go up. If everyone’s saving, inflation tends to go down. Economic theories differ, but some believe that moderate inflation is good for the economy.

The Bank of England tries to keep inflation around 2%, helping everyone plan for the future. This is the inflation target set by the government. If inflation goes too high, the Bank of England will often increase interest rates to encourage people to save. If inflation is too low, it will lower rates instead to encourage people to spend.

Are Premium Bonds a good option for saving?

Rather than earning you interest on your money, premium bonds, also known as premium savings bonds, give you the chance to increase your cash through a monthly prize draw. Every £1 you put in has a unique bond number and your numbers are entered into the draw for the chance to win up to £1 million, although prizes start at £25. The more money you have, the better your chances.

Premium bonds are issued by National Savings and Investments (NS&I) – a government department backed by HM Treasury – which means your money’s very safe. And any interest you gain in prizes is tax free. However, thanks to the personal savings allowance, which offers tax-free interest of up to £1,000 a year (or £500 for higher rate taxpayers), most people no longer pay tax on their savings interest anyway.

In May 2021, NS&I put your chances of winning at 34,500 to 1 (for every £1 bond), giving you a 1% interest rate. That’s higher than a lot of ISAs, plus premium bonds come with the added advantage that they don’t count towards your personal savings allowance.

It all comes down to whether you want to try your luck – because if you’re banking on winning the big prize, that’s exactly what you’ll need.

Like this?

Then you'll like these

Sajni Shah - Consumer expert on utilities and money

Sajni is passionate about building products, allowing Compare the Market to help you make great financial decisions. She keeps track of the latest trends and evolving markets to find new ways to help you save money.

Learn more about Sajni