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Published 06 June 2023
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Why High UK Inflation Means Your Money Costs More and Buys Less – and What you Can do About it

Rising interest rates, high inflation and a flat economy mean your money is becoming more expensive, but less valuable. 

The knock-on effects of the Bank of England aggressively hiking the base rate to combat UK inflation makes borrowing money more expensive and saving money more rewarding. 

Against a backdrop of rising prices that erode your spending power and a sluggish economy, even when you do get a pay rise it is unlikely to keep pace with UK inflation.

So what can you do when money costs more but buys less? Is it better to pay off debt or save?

How can money become more expensive, but less valuable?

It’s an odd idea to read (and to write) but bear with us. 

The official measure of inflation in the UK, CPI (consumer prices index), dropped back into single figures in April to 8.7% from 10.1% in March. But ‘core’ CPI, which excludes more volatile food and energy price rises, produced a shock by hitting a 30-year-high of 6.8%. 

Core inflation is historically slower to rise, or fall. And, unless your wages increase at the same rate or faster, rising prices mean you have less money to spend in real terms. 

In an attempt to get inflation back under control, the Bank of England has already taken the unprecedented step of hiking the base rate 12 successive times from a historic low of 0.1% to 4.5% to combat the rising cost of living and get inflation back under control.

What’s more, further rate rises now look even more likely, with some forecasters predicting a peak of 6%, which would be the highest rate since before the 2008 financial crash. 

All signs point to us having come to the end of a cheap money era. So how do you balance the need to potentially pay off your debts and save for the future in such a situation?

Now is the time to pay off debt and shop around

In short, you need to get to grips with what rising interest rates will mean for any debts you have and, if possible, put in a concerted effort to clear what you can.

Once your debt repayments are under control, you can turn your attention to saving, and ensuring you get the best rates that you can. If you haven’t switched current or savings accounts in a while, you can probably get a higher interest rate, or at least a bonus, for switching bank accounts.

And, if your mortgage is up for renewal in the next six months it is a good idea to discuss your options with a whole-of-market broker sooner rather than later, certainly before the final three months of your current term.

Jonathan Chesterman, debt advice policy manager at national debt charity StepChange, says: ”Priority debts can include your mortgage, rent, council tax, energy bills, among others, and the consequences of missing these payments can be serious, therefore they should always be paid off first.”

Paying down debts with higher rates of interest, such as credit cards and overdrafts, should also be prioritised before focusing on saving money. That’s because the interest you pay for expensive debt is likely to be higher than the interest you can earn from a savings account. 

Sarah Coles, head of personal finance at Hargreaves Lansdown, says: “Expensive short-term debts should be your first port of call. Overdrafts and credit cards can charge enormous rates of interest that make it even harder to stay on top of your finances, so any cash you can free up should go into paying this down as quickly as you can.”

Don’t overlook your savings

Turning your attention to your savings, ensuring you have an emergency fund, a pot of money you can use to cover unexpected costs such as a loss of income, a boiler breakdown or car repairs, is the next sensible step. 

“As a rough rule of thumb, someone of working age should have between three and six months of essential expenses in a competitive easy access account to cover emergencies,” advises Coles.

However, the amount of money you should save will vary depending on your living situation and financial circumstances.

Coles continues: “Where they sit between three and six months depends on all sorts of things from how secure their job is, to their health, the number of people who rely on them financially, and any other support they have – from insurance to family. It means if you’re a typical spender living alone your ideal emergency savings safety net could be somewhere between £3,000 and £8,000.”

The key to building an emergency fund is consistently saving what you can afford. And it is important to recognise that paying off your debts and saving money are not mutually exclusive concepts – having savings to draw on in an emergency could avoid the need for you to borrow more and increase your debts. “If you have an emergency and need to fall back on your savings, you’ll be grateful for every penny,” says Coles.

Image source: Getty Images

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