What are the main causes of inflation?

Production costs, demand, and fiscal policy all influence inflation. For example, if it costs more to produce goods, those increases may be passed on to customers. Similarly, if demand increases, manufacturers and sellers can raise prices. Fiscal policy is set by the government and helps to manage the economy. For example, if the government increases its spending or cuts taxes, this can encourage people to spend more, boosting demand for goods and raising inflation.

How inflation affects your personal wealth (and how to protect it)

Inflation doesn’t just affect what we buy; it also impacts savings, so what you have in the bank now might not have the same purchasing power in five or ten years’ time. In this article, we explain how inflation can erode your hard-earned savings and look at how personal financial planning can protect the wealth you’ve accrued.

Updated: 29.07.26

By Paul Steed

What is inflation, and why does it matter?

Inflation occurs when the prices of goods and services rises over time. In the UK, inflation is measured by the Consumer Price Index including owner-occupiers’ housing costs (CPIH), which helps analysts compare the costs of essential items across months and years.

The rate of inflation can rise or fall, but steady (and low) inflation levels help create economic stability. Volatile inflation rates can ultimately cause economies to collapse. On a personal level, steady inflation keeps prices relatively stable, enabling consumers to plan and budget their finances.

In the UK, the government sets a target rate of inflation (currently 2%). It’s the Bank of England’s responsibility to keep the actual rate of inflation as close to this as possible.

How does inflation affect your savings?

Inflation can erode the value of savings as prices rise. For example, if you spend £100 on food today, that £100 may not buy you the same amount of food next year after inflation has increased the cost of those goods. When it comes to savings, the impact can be even greater, especially if your interest rate is lower than inflation, as it means your savings won’t keep up with rising costs.

So, while having access to cash is good for emergencies, savings kept in a traditional savings account or cash ISA are more likely to decline in value every year as inflation increases, so your money doesn’t go as far. As an example, you want to buy a car worth £15,000 and currently have £14,750 in savings. At the start of the year, you open a bank account with an interest rate of 2.5% so that by the end of the year, you should have £15,118.75, which is enough to buy the car. But if inflation is 4%, the cost of the car has now increased to £15,600, so your savings wouldn’t be sufficient if you didn’t add additional funds.

The impact of inflation on borrowing and mortgages

Inflation and interest rates are closely connected. In periods of high inflation, interest rates are often increased to keep spending in check. This typically means you’ll pay more on variable-rate loans and mortgages, where the interest you pay changes with the Bank of England’s base rate. Interest rate rises will also affect other types of borrowing, such as credit cards.

Who benefits most from inflation?

If you have a fixed-rate loan, mortgage, or debt, then you’ll benefit from inflation (if the rate is less than inflation). That’s because, despite the value of goods and services rising, the value of your debt stays the same. For example, if you’re paying back £100 every month, inflation erodes its real value over time.

Strategies to protect your finances from inflation

There are no guaranteed ways to protect your finances, but a common wealth management strategy is to invest with the aim of generating returns that protect against inflation.

Most investments fall into categories (asset classes):

Shares – where you buy a stake in a company.
Property – when you buy or invest in commercial or residential buildings.
Bonds (also known as fixed interest securities) – when you loan money in exchange for an IOU and regular interest payments. Bonds are offered by both large organisations and governments.

However, all investments come with risk: your returns may not be as you hoped, or you may lose money. If you’re considering investing, such as in a stocks & shares ISA, you should be willing to do so for at least five years.

Terms that you’re likely to come across include:

Diversified investing

Diversified investing is about spreading risk. This could mean buying into different asset classes or spreading your investments across different industries and locations. If you choose to invest via a financial planner, they will assess your risk tolerance, which often determines the diversification of your investment portfolio.

Understanding the 70/30 rule

This is a general rule of thumb that’s often used as an example of how best to select assets. It’s based on allocating 70% of your money to equities (or stocks), which drive growth, and 30% to bonds, which are traditionally viewed as less risky than equities. How you actually split your investments depends on your risk tolerance and when you expect to see returns.

Cashflow modelling

Cashflow modelling is a way to calculate and forecast your finances over time. It’s often used by financial planners as part of retirement planning, as it can simulate different scenarios and help you understand whether you’ll have enough money to live the lifestyle you want.

Using a range of forecasting tools, a financial planner can show you the effects of inflation and run different scenarios to test whether your savings and investment plans will meet your future financial needs.

FAQ

Expert guidance when you need it most

Consulting an independent financial advisor (IFA) can help you better understand your current financial position and provide greater clarity on the likely effect of inflation and what investments are worth considering based on your plans and appetite for risk. Don’t forget that anyone giving you financial advice must be authorised to do so and must be listed on the Financial Services Register.

You can find out more about how to make the most of your money, savings, and investments by speaking to one of our personal financial planning experts on 01603 967967.

The value of investments and any income from them can go down as well as up and you might not get back the original amount invested. The past is not a guide to the future. The value of tax benefits depends on your individual circumstances. Tax laws can change.

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How inflation affects your personal wealth (and how to protect it)

In this article

In this article

What is inflation, and why does it matter?

How does inflation affect your savings?