Inflation and Interest rates– How Do They Affect Me?

There is a lot of noise at the moment about whether interest rates will start to rise from their record low levels and inflation rate percentages seem to appear in most articles relating to finance. But what does this actually mean and how will it affect our day to day lives?

Inflation is basically the rate of increase in prices for goods and services. So if inflation is rising it means we are paying more for basic goods like bread, petrol, alcohol, leisure pursuits like going to the cinema etc. Inflation rates are usually given as percentages, so you may see a headline saying ‘Inflation has risen by 5% this year’ which means we are paying 5% more for basic goods than we were the previous year.

There are different ways of measuring inflation. You may have heard of the Consumer Prices Index (CPI) or the Retail Prices Index (RPI). The difference between them is the Retail Prices Index includes housing costs such as mortgage interest payments and council tax. They also use different formulae to calculate inflation which is why you may see different figures banded about. The CPI inflation rate is generally lower than the RPI because it takes into account the fact that when prices rise, some people switch to products that have gone up by less.

Why is it so important and what is the relationship between inflation and interest rates?

Governments use inflation to help set interest rates, which subsequently affect how much we pay on our mortgages, loans, credit cards and how much we can earn from saving accounts, ISAs and more. A rise in inflation – depending on how much, can signal a subsequent rise in interest rates, because Governments may try to control the inflation rise. Conversely if inflation is likely to rise by a small amount or not rise at all, Governments may choose to cut interest rates or keep them static.

Inflation can also impact some people’s incomes. If you have an index-linked state benefit, pension or savings product and inflation rises, you could benefit from this. Some companies also use the level of inflation to set annual pay rises.

There is a strong relationship between interest rates and inflation. Interest rates are the cost of money. Put simply, if you pay 0% interest rate to borrow £100 it costs you nothing to borrow that £100, so you would pay back just the £100. If you pay 50% interest rate to borrow £100 it costs you £50 to borrow £100, so you would pay back £150. If interest rates are low (as they are currently), spending increases because the cost of goods is relatively cheaper. This in turn means that the economy grows but this could mean inflation increases and prices of goods rise.

Why does this matter to me?

If interest rates are low and people have access to cheap money – as has been the case for the past few years, it means there are more people who can afford goods like houses and cars, so this drives the price up.

In August 2017, the Bank of England held interest rates at 0.25%, predicting that higher inflation would eat into people’s spending power – in other words the rising costs of goods would result in us spending less. A combination of the rising costs of goods, us buying less goods or seeking the best deals, low wage growth and the unknown Brexit negotiations seems to be keeping an interest rate rise at bay, but whether this will change in the coming months is an unknown. Some are predicting a rise from 0.25% to 0.5% by mid-2018.

What can I do to manage my finances in this uncertain climate?

If you have a fixed rate mortgage coming to an end over the next six months, have a look around, as you can secure a deal in advance.  Likewise you can look to switch over credit cards/store cards / loans to the best deals. A number of website publish the best deals – just Google ‘best credit card deals’ or ‘best fixed rate mortgages’.

At TFS Loans, the interest rates on our loans remains fixed over the entire term, so your loan repayments will not be affected by a national interest rate rise.

TFS Loans are specialist Guarantor Loan lenders. We offer Guarantor Loans from £1,000 – £15,000 for a range of purposes including large purchases like cars, home improvements, weddings and other events, debt consolidation and for start-up/small businesses.