How inflation affects your money

Inflation is the general rise in prices over time. When things cost more, each pound you hold buys a little less, so the value of money slowly slips even if the amount never changes. The main UK measure is CPI, the Consumer Prices Index, and the Bank of England aims to keep it at 2% a year. This is why £100 stashed in a drawer feels like less in ten years' time.

What inflation is, and what CPI measures

Inflation is the rate at which prices in general rise over a year. If inflation is 3%, then on average things cost 3% more than they did twelve months ago. It is not about one item getting dearer; it is the broad, across-the-board climb in the cost of living.

The UK's headline measure is CPI, the Consumer Prices Index. Each month the Office for National Statistics (ONS) checks the prices of a fixed basket of around 700 everyday goods and services, covering everything from groceries and clothing to rail fares and streaming subscriptions. The basket is updated each year to reflect what people actually buy. The change in the cost of that basket over the year is the CPI inflation rate.

The Bank of England has a target of 2% CPI inflation, set by the government. A low and steady rate makes it easier for households and businesses to plan, which is the point of having a target at all. If inflation moves more than one percentage point either way, above 3% or below 1%, the Governor must write to the Chancellor to explain why.

How inflation eats your buying power

Buying power, sometimes called purchasing power, is simply how much your money can actually buy. Inflation chips away at it. The pounds stay the same, but each one stretches over a bit less, so a fixed sum quietly buys less as the years pass.

The effect compounds, because each year's rise is applied on top of the last. To see what a sum will buy in future, in today's money, you divide it by the growth in prices: amount ÷ (1 + rate) raised to the number of years. The table below shows £10,000 set aside today, at a steady 2.5% inflation rate, in terms of what it would buy at each point. Treat it as a guide to the scale of the effect, not a prediction.

After 20 years the same £10,000 buys roughly £6,100 of what it can buy today. The cash has not vanished; its value in real terms has shrunk by almost two-fifths.

Real vs nominal: the difference that matters

Two words come up whenever people talk about inflation, and getting them straight makes everything else click.

• Nominal is the plain cash figure, the number of pounds, with no adjustment. Your bank balance is a nominal amount.
• Real strips out inflation to show buying power: what the money is actually worth in goods and services. A real figure is stated in the prices of a chosen year, often today.

The gap between them is why a pay rise can leave you no better off. A 2% rise is a 2% nominal increase, but if prices also rose 2%, your real pay has not moved at all. The same logic applies to any sum: if the number of pounds grows more slowly than prices, its real value is falling even as the balance ticks up.

What it takes to keep pace

Flip the question around. Instead of asking what a sum will buy later, ask how much you would need later to buy what it buys today. That is the cost of keeping pace, and it works the other way: amount × (1 + rate) raised to the number of years.

Take the same £10,000 at a steady 2.5%. In 20 years you would need about £16,400 to buy what £10,000 buys now. So a sum has to grow by roughly that much just to stand still in real terms. Anything less, and you are quietly going backwards. This is the practical reason people look beyond a basic account for money they will not touch for years.

Try it on your own figure

The £10,000 example uses one steady rate to keep the maths clear. To run your own amount, rate and number of years, both ways round, open the inflation calculator and change the figures to see how much buying power a sum keeps or loses over time.

What it means for savings

The honest test for any savings or return is whether it beats inflation. If your money grows at 3% in a year when prices rise 4%, the balance is higher in pounds but lower in real terms: it buys less than it did. Growing in cash and shrinking in buying power can happen at the same time, and a low-interest account through a spell of higher inflation is the usual culprit.

That does not mean cash is pointless. An easy-access buffer for emergencies is worth holding even if it lags inflation, because you need it to be safe and instant rather than to grow. The question is sharper for larger sums you will not need for years, where the difference between matching prices and falling behind adds up. How money builds up over time is covered in how savings grow and how compound interest works, and the idea of saving enough to live off your money is in what is FIRE. None of this is advice, and no return is guaranteed.

Common questions

What does inflation do to the value of money?

It lowers what each pound buys. When the general price level rises, the same money stretches over fewer goods and services, so your buying power falls even though the number of pounds in your hand is the same. At 2.5% a year, prices roughly double over about 28 years, which halves what a pound buys.

What is CPI in simple terms?

CPI is the Consumer Prices Index, the main UK measure of inflation. Each month the Office for National Statistics tracks the prices of a fixed basket of around 700 everyday goods and services, from food to fuel, and works out how much the cost of that basket has changed over the year. That percentage change is the CPI inflation rate.

Why does the Bank of England target 2% inflation?

A low, steady rate lets households and businesses plan with some confidence about future prices. The government sets the Bank of England a target of 2% CPI inflation. If inflation drifts more than one percentage point either side of that, so above 3% or below 1%, the Governor has to write to the Chancellor to explain why and what the Bank will do about it.

Is a small amount of inflation a bad thing?

Not necessarily. A small, predictable rate is generally seen as healthier than prices falling, because falling prices can make people delay spending, which slows the economy. The concern is buying power: at a steady 2.5% a year, money loses roughly a quarter of its real value over 20 years, so cash left idle quietly shrinks in what it can buy.

How can I protect my money from inflation?

There is no way to switch inflation off, but you can aim for your money to grow at least as fast as prices. That usually means not leaving large sums in an account paying less than the inflation rate, and weighing up savings and investing for money you will not need soon. None of this is advice, and returns are never guaranteed.

Are these inflation figures a forecast?

No. They assume one steady rate held for the whole period, which never happens in real life: inflation rises and falls year to year. They are a guide to show the direction and rough scale of the effect, not a prediction of future prices, and they are not financial advice.

About this article

Written by the calcd team. We build UK money calculators and explain the numbers behind them in plain English. We checked this article against the Bank of England, the Office for National Statistics and MoneyHelper. The figures here use one steady inflation rate to show the direction and rough scale of the effect; real inflation moves around, so treat them as a guide, not a forecast, and not financial advice. Last updated June 2026.