High inflation has dominated headlines over the last two years. With the rate now slowly nearing the Bank of England’s (BoE) target, taking stock of what it means for your finances could be useful.

The BoE is responsible for managing inflation and aims to keep it at 2%. The central bank explains keeping inflation stable helps everyone plan for the future.

Several factors combined in 2021 that led to the rate of inflation soaring. It reached a peak of 11.1% in October 2022 – a 41-year high. In the 12 months to November 2023, it’s still above the BoE target but has fallen to 3.9%, according to Office for National Statistics data.

The BoE’s Monetary Policy Committee (MPC) said it expects inflation to continue falling towards the 2% target in 2024. However, it doesn’t expect to reach the target until the end of 2025.

Declining inflation doesn’t mean the cost of goods and services will fall

While slowing inflation could be a good thing for your long-term finances, it’s unlikely to deliver a boost to your everyday budget.

Falling inflation doesn’t mean the prices of goods and services fall, it simply means the pace at which the costs are rising is slowing down. So, it might be a good idea to review your day-to-day expenses. If your income hasn’t increased at the same rate as inflation, you could find your disposable income has fallen in real terms.

For example, let’s say your income was £3,000 a month in 2020. According to the BoE’s inflation calculator, your income would need to have increased by more than £630 a month just to maintain the same lifestyle in November 2023.

Falling interest rates could be beneficial if you’re a borrower

While the rate of inflation might not reduce the price you pay for goods and services, it could affect the cost of borrowing.

One of the main ways the BoE has sought to tackle inflation is by increasing its base interest rate. Higher interest rates can lower spending in the economy as both consumers and businesses tighten their belts.

As of December 2023, the BoE’s base interest rate is 5.25%, which compares to a rate of just 0.1% in November 2021. The MPC expects to maintain this rate through the first half of 2024 before gradually reducing it to reach 4.25% in 2026.

So, if you have a mortgage, credit card, personal loan or other form of borrowing, you might start to benefit financially from lower interest rates in 2024. For some, this could have a positive effect on their budget.

Making inflation part of your long-term goals could help keep you on track

The period of high inflation over the last two years has highlighted why it’s important to consider the rising cost of living when you’re making long-term plans.

Even when inflation meets the BoE’s target, the gradual rise of goods and services can add up.

Between 2010 and 2020, inflation averaged 2% a year. That might not seem like a lot, but over a decade it could gradually reduce your spending power if your income is static.

If you retired in 2010 and planned to take a monthly income of £2,000 from your pension for the rest of your life, you’ll start to notice your money doesn’t stretch as far relatively quickly.

Indeed, the BoE’s inflation calculator suggests your income would need to have increased to more than £2,400 by 2020 to maintain the same standard of living.

Now, imagine the effect stable inflation could have on your income needs over a retirement that might span several decades. During that time, you may also experience periods of high inflation, which could reduce your spending power even further.

It’s not just retirement planning that could be affected by inflation, but any of your long-term goals. Whether you’re setting aside money to support your children through university or to buy property in the future, inflation may affect your target and the steps you need to take.

Do you want to make inflation part of your financial plan?

Considering how outside factors, like inflation, might affect your goals could help your financial plan stay on track. Please contact us to talk about creating a long-term financial plan that could give you confidence, even when inflation is high.

Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.