Inflation determines how far your money goes. When prices rise faster than your income, your standard of living falls. Understanding how inflation is measured, what drives it, and how it affects your savings, pension, and spending is essential for making informed financial decisions. This guide covers the key inflation measures used in the UK, provides recent historical context, and explains the practical impact on your finances.
CPI vs RPI: Two Ways to Measure Inflation
The UK uses two main inflation measures, and they often give different results:
| Feature | CPI | RPI |
|---|---|---|
| Full name | Consumer Prices Index | Retail Prices Index |
| Includes housing | No (CPIH does) | Yes (mortgage interest, council tax) |
| Formula | Geometric mean (tends lower) | Arithmetic mean (tends higher) |
| Official status | Bank of England target measure | Being phased out by 2030 |
| Typical difference | Baseline | 0.5-1.0% higher than CPI |
CPIH is a newer variant that includes owner-occupier housing costs (using a rental equivalence method). It is increasingly used alongside CPI but has not replaced it as the primary target measure.
How Inflation Is Measured
The Office for National Statistics (ONS) tracks the prices of around 730 goods and services each month from approximately 20,000 retail outlets across the UK. This "basket of goods" is updated annually to reflect changing consumer habits. For example, oat milk was added in recent years while DVD recorders were removed.
Each item in the basket carries a weight based on how much of an average household's spending it represents. Housing, water, electricity, and gas carry the heaviest weight (around 30%), followed by transport (around 13%) and food and drink (around 11%).
Recent UK Inflation History
| Year | CPI (annual avg) | Key Event |
|---|---|---|
| 2020 | 0.9% | COVID-19 lockdowns suppressed demand |
| 2021 | 2.6% | Reopening, supply chain disruption |
| 2022 | 9.1% | Energy crisis, Ukraine war (peaked 11.1% in October) |
| 2023 | 7.3% | Food prices, persistent core inflation |
| 2024 | 2.5% | Energy cap reductions, rates held high |
| 2025 | 2.1% | Return to near-target levels |
The 2022-2023 inflation spike was the most severe in four decades. The primary drivers were energy prices (following Russia's invasion of Ukraine), post-pandemic supply chain chaos, strong consumer demand as economies reopened, food prices hit by drought and fertiliser costs, and a weaker pound that increased import costs.
How Inflation Affects Your Money
Savings
Inflation is the silent enemy of cash savings. If your savings account pays 3% interest but inflation is 4%, your money is losing 1% of its purchasing power each year. Over a decade, this effect compounds dramatically. £10,000 saved at 2% interest with 4% inflation would have the purchasing power of roughly £8,200 after 10 years.
To protect against inflation, consider:
- NS&I Index-Linked Savings Certificates (when available) track inflation directly
- Premium Bonds offer tax-free prizes, though returns are not guaranteed
- Cash ISAs at the best available rates shelter returns from tax
- Stock market investments have historically outpaced inflation over long periods, though with greater volatility
Pensions
The State Pension is protected by the "triple lock," which increases it each April by the highest of CPI inflation (September figure), average earnings growth, or 2.5%. This has been particularly generous during the recent high-inflation period. For 2026/27, the State Pension increased by the triple lock mechanism to maintain purchasing power.
Private and workplace pensions with fixed annual increases may fall behind during high inflation. Defined benefit pensions linked to CPI are better protected, but many older schemes link increases to the lower of CPI and a cap (often 2.5% or 5%).
Wages
When inflation outpaces wage growth, workers experience a real-terms pay cut even if their nominal salary stays the same or increases slightly. Between 2022 and 2024, real wages fell for many UK workers as inflation significantly exceeded pay settlements. The squeeze was particularly acute for public sector workers, where pay rises were capped well below the inflation rate.
Mortgages and Debt
Inflation has a mixed effect on borrowers. Fixed-rate mortgage holders are protected from rate rises during their fixed term. Those on variable rates see payments increase when the Bank of England raises the base rate to combat inflation. However, inflation erodes the real value of debt over time, so in one sense, moderate inflation benefits long-term borrowers.
The Bank of England's Role
The Bank of England's Monetary Policy Committee (MPC) sets the base interest rate with the aim of keeping CPI inflation at the 2% target. When inflation rises above target, the MPC raises interest rates to cool demand. When inflation falls below target, they cut rates to stimulate spending. The base rate was raised from 0.1% in December 2021 to 5.25% by August 2023 in response to the inflation surge, before beginning to ease as inflation fell.
See how inflation has changed the value of money over time. Compare past and present purchasing power.
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