We've been hearing a lot about inflation in the news recently and with all the discussion around it it may be a little confusing. In this blog we will delve into what inflation is and how it affects YOU!
So, what exactly is inflation?
Inflation is a general increase in the prices of goods and services in an economy.
As the cost of goods and services rises each unit of currency buys you less and less, inflation corresponds to a reduction in the purchasing power of money.
In simple terms inflation is the rate at which prices increase over a given time period.
How is inflation calculated?
The Office for National Statistics (ONS) works out the rate of inflation every month by checking the prices of a range of items in a ‘basket’ of goods and services. They record the price of over 700 items that people regularly buy, ranging from small, everyday items like bread and milk to larger items and services like a car or a holiday.
The ONS will look at the overall cost of this ‘basket’; the total cost will give them the overall price level. The overall price level is better known as the consumer price index (CPI). To calculate the rate of inflation the ONS will make a comparison between the current CPI and what it was the previous year. The percentage change between the two values is the rate of inflation.
Is high inflation bad?
Every year the Government sets a target for how much overall prices should go up. In the UK that target is 2%. It’s the job of the Bank of England to keep inflation at that target.
A little bit of inflation is helpful, a low, stable rate of inflation helps to create and build a healthy economy. However, high and unstable rates of inflation can be harmful to an economy. If prices are unpredictable, it becomes more difficult for people to plan their finances, their expenditure, and affects what they can save or invest.
In extreme cases, high rates of inflation can cause an economic collapse.
What does the BoE do to manage inflation?
One of the jobs of the Bank of England it setting monetary policy. This is a set of tools used to keep inflation low and stable. The main way the BoE does this by adjusting interest rates. Interest rates is the amount of money people get on top off any savings they have in an account. Interest rates is also the charge you will need to pay on any loans and mortgages.
The link between interest rates and inflation?
By the BoE setting higher interest rates it becomes more expensive for people to borrow money and encourages saving. This should result in people spending less on goods and services. If people spend less as a whole on goods and services, prices will tend to rise slower. This lowers the rate of inflation.
The opposite of this is also true.
How does inflation affect mortgage rates?
Banks will look to maintain their margins, so if the cost of borrowing money from the Bank of England, to give to end consumers for their mortgages, goes up they are likely to pass that increase on which is why when the base rate rises so do mortgage rates and mortgage payments.
So when mortgage repayments are higher it restricts spending on other goods and services and assists in the reduction of demand for those goods and services. When demand drops for goods their prices should follow and price reductions mean that inflation will start to fall.
If you have a fixed rate mortgage then the change in the rate of inflation will not affect your mortgage repayments until the end of that fixed term. Tracker rates are directly linked to these so the increase will be directly linked to the rise. If you are on a variable mortgage it is very likely that when the Base Rate increases, lenders will want to keep their margins and the bank/lender will pass those increases onto mortgage customers.
YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE
If you are concerned about how inflation has affected your mortgage repayments or you want to discuss whether now is the right time for you to get a mortgage, then don't hesitate to get in contact!