Prices are rising faster than they have done for 40 years.
The Bank of England says the recent increases in energy bills, which are set to be three times more than they were a year ago, will drive inflation – the rate at which prices rise – even higher, to 13%.
The increase in the cost of living is putting a squeeze on people’s finances, as wages fail to keep up.
What is inflation?
Inflation is the increase in the price of something over time.
For example, if a bottle of milk costs £1 and that rises by 5p compared with a year earlier, then milk inflation is 5%.
Every month a figure is released, estimating how much prices are rising overall – it’s currently at 10.1%.
Why are prices rising so fast?
The Bank of England’s governor Andrew Bailey has said “the Russia shock is now the largest contributor to UK inflation”. But economists agree that there are many factors, including:
Not all prices behave the same way. The cost of some other goods and services have increased only slightly or stayed the same.
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What’s happening to wages?
Average wages, not including bonuses, rose by 4.7% in the year to June 2022.
But when you take inflation into account, the real value of that pay actually fell by 3% compared to 12 months ago.
Pay including bonuses was down 2.5%, when adjusted for inflation.
Who measures the UK’s inflation rate?
To come up with an inflation figure, the ONS keeps track of the prices of hundreds of everyday items. This is known as the “basket of goods”.
The basket is constantly updated. Tinned beans and sports bras were added this year, reflecting a rising interest in plant-based diets and exercise.
Each month’s inflation figure shows how much these prices have risen since the same date last year. This is known as the Consumer Prices Index (CPI).
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What’s happening in other countries?
Other countries are also experiencing a cost of living squeeze.
Many of the reasons are the same: increased energy costs, shortages of goods and materials and the fallout from Covid.
In the United States, inflation hit 9.1% in the 12 months to June – a 40-year high, the US Labor Department said.
When will inflation come down?
Despite predicting that inflation will go higher in the autumn, the Bank of England says the “current high rates of inflation are not likely to last”.
It forecasts inflation will peak this winter at 13.1% – then fall to 2% in about two years.
But not all economists are so sure. Historically, when inflation has risen above 9% it has taken years, not months, to recover.
What can be done to tackle inflation?
The Bank of England’s traditional response to rising inflation is to raise interest rates. This can encourage people to save, but means some people with mortgages see their monthly payments go up.
Raising interest rates also makes borrowing more expensive and – it is hoped – people have less money to spend. As a result, they will buy fewer things and prices will stop rising as fast.
But when inflation is caused by things like rising energy prices worldwide, there is a limit as to how effective UK interest rate rises can be in slowing inflation.