Inflation is expected to have risen to 7.1 per cent when official statistics are released on Wednesday, economists predict, mainly due to an uptick in fuel prices.
The Office for National Statistics (ONS) will publish figures this week detailing how the average prices of goods and services changed in the year leading up to August.
Experts predict that inflation – as measured by the Consumer Prices Index (CPI) – could go up from around 6.8 per cent, as it was last month, to 7.1 per cent.
If this forecast is correct, it will deal a fresh blow to those struggling with the cost of living and cast Rishi Sunak’s pledge to halve inflation by the end of this year into doubt.
Here’s why inflation is set to jump upwards, and what it means for your money.
Why is inflation forecast to increase?
Inflation has fallen sharply in the last few months, from 10.1 per cent in October last year to 6.8 per cent last month, but this trend could well end in this week’s release.
Chancellor Jeremy Hunt has suggested that there will be a temporary increase to inflation in August’s data and forecasts agree.
Capital Economics is expecting inflation to rise from 6.8 per cent in July to 7.1 per cent in August.
“We think that’s due to a 4 per cent month on month rise in petrol prices in August compared to a 6.8 per cent fall last August,” explains Ashley Webb, an economist at the organisation.
But countering long term fears, Mr Webb has said that Capital Economics still expects the core inflation figure, which ignores more volatile price increase such as energy, food, alcohol and tobacco, to fall from 6.9 per cent to 6.7 per cent, and services inflation to fall as well.
What will happen to interest rates?
Inflation is one of the main factors that influences whether the Bank of England chooses to raise or lower the base rate, which determines how expensive it is for banks to borrow money from it.
The base rate currently sits at 5.25 per cent, after the Bank opted for a 0.25 percentage point raise in August, its 14th consecutive increase.
The Bank generally raises rates to combat inflation. The logic is that if borrowing is more expensive then people have less money to spend, and so there is less demand for goods and services.
In recent weeks, Andrew Bailey, the Bank’s Governor, has suggested that interest rates may be near their peak. Economists have also told i that this could be the last rate increase in the current cycle.
Mr Webb has said the rebound in inflation may raise some concerns about the durability of the downward trend in inflation and will probably be followed by an interest rate rise, from 5.25 per cent to 5.5 per cent, when the Bank next determines rates this Thursday.
But he adds: “As long as core inflation and services inflation ease, Thursday’s rate hike may prove to be the last hike in this cycle.”
If core and services inflation do not fall, we could see a larger increase in the base rate, or further rate rises to come.
Will mortgage rates go down?
Mortgage costs can be impacted by inflation a result of the impact on interest rates.
Tracker mortgages follow the Bank’s base rate while standard variable rate mortgages generally do so too, meaning that homeowners with these loans will be immediately impacted by the inflation figure, given the Bank rate will be set the following day.
If inflation falls then a higher interest rate rise – and therefore a dramatic rise in the rates of these mortgages – is less probable, but if we see core inflation and services inflation increase, then the chance of these rates going even higher increases.
Fixed-rate products are not immediately affected by any change in interest rates, so those who are part-way through their term will not see an impact. However, shifting rates does have an impact on the products offered to new customers and those remortgaging – though these are determined by the long-term trends in the cost of borrowing, rather than specific rate rises.
Nick Mendes, of brokers John Charcol, said that based on current forecasts, of one more interest rate increase to 5.5 per cent this week, borrowers can “expect to see lenders continue to reprice downwards albeit sporadically”.
“If this trends continues to run its course we could see rates around 4.5 per cent by the end of October,” he said.
Higher-than-expected inflation could throw this off course though and slow the rate of decreases, while a very low inflation figure could mean borrowers reprice downwards quicker.
What about my savings?
You might think that a higher base rate – nudged up by higher inflation – means that banks will start increasing what they pay to savers in return for their deposits.
This is somewhat true as, in general, as the base rate increases, savings accounts generally pay higher rates. With more rate rises expected, savings rates should also climb correspondingly.
However, inflation is bad news for savers as it erodes the value of money held in the bank. Even though the best paying easy access accounts are offering 5 per cent or more, inflation is still nearly 2 per cent higher – meaning your savings are effectively worth 2 per cent less each year, comparatively speaking.
Anna Bowes, founder of Savings Champion, has previously noted that falling inflation can help “mitigate” against this to an extent if interest on savings accounts stays the same.
How does inflation affect food prices?
While inflation is a measure of price rises, it accounts for a wide range of goods and services – including petrol, insurance and other varying costs – and does not affect them all equally.
Food inflation has been running higher than average price rises, however. In July’s ONS data it stands at 14.9 per cent. According to analysts at Kantar, it fell by 2.2 percentage points to 12.7 per cent in the four weeks to 6 August, 2023.
The war in Ukraine reduced the amount of grain available, pushing up global food prices, which was compounded in the UK in February by a shortage of salad and other vegetables, which took food inflation to a 45-year high.
Although food inflation has been falling in recent months, this does not mean food prices are decreasing. It just means they are increasing in price at a slower rate than before.
That means that the prices you see on supermarket shelves are unlikely to fall any time soon – at least, not just because inflation is falling.
What does inflation falling mean for your pension?
As with savings, higher inflation is generally bad news for people with pensions – or those currently saving for one – as it reduces the true spending power of their pots. If inflation is falling, that means that this effect is lessened.
For example, if you are 67 and plan to retire in a year, assuming you have a pot of £87,500 in today’s money – roughly the average someone older than 50 will have by retirement, according to Pension Bee – then one year later, if inflation runs at 10 per cent, and your investment growth is 5 per cent, your pot would be worth £91,263.
But in real terms, your pot would be worth the equivalent of £83,650, adjusted for today’s money.
