What Is Inflation?

What is inflation?

Inflation is the rate at which prices across the economy rise over time. If inflation is 3%, things cost roughly 3% more than they did a year ago. A £50 shopping basket now costs £51.50. In the UK, inflation is officially measured by the Consumer Prices Index (CPI), published monthly by the Office for National Statistics (ONS). The Bank of England targets a 2% CPI inflation rate.

A small amount of inflation is considered healthy. It encourages spending (why buy something tomorrow when it costs more?) and gives businesses confidence to invest. The problem comes when inflation gets too high, or when it falls so low that it tips into deflation.

What is the current UK inflation rate?

UK CPI inflation was 3.5% in the 12 months to September 2026. The ONS published that figure on 21 October 2026. It was up from 3.1% in the 12 months to August 2026. CPIH, which also includes owner occupiers’ housing costs, was 3.6% over the same period, up from 3.3%. The ONS said the largest upward contribution came from transport, particularly motor fuels.

So prices are still rising, and the rate of increase picked up in September. Falling inflation does not mean things get cheaper. It means the rate of increase has eased. The higher prices from previous years stay where they are.

The ONS publishes a new CPI figure every month, usually mid-month. Each figure covers the 12 months to the previous month. That monthly release shapes the debate about the Bank of England base rate, because the Bank’s job is to keep CPI close to 2%.

How is inflation measured in the UK?

The main measure is the Consumer Price Index (CPI). The Office for National Statistics (ONS) tracks the prices of around 700 goods and services. These make up a virtual ‘basket’ of things households typically buy, from bread and fuel to cinema tickets and laptops. Each month, the ONS measures how much that basket has changed in price compared with a year ago.

You might also hear about CPIH (which adds housing costs like rent) and RPI (an older measure still used for some rail fares and student loan interest). CPI is the official government and Bank of England measure.

What does inflation mean for your money?

Inflation erodes the real value of money over time. If your savings earn less interest than the inflation rate, your money loses purchasing power, even as the balance grows. A 2% pay rise when inflation is 5% is effectively a real-terms pay cut. Inflation also affects mortgages, pensions, tax and debt. The effects differ depending on which side of them you are on.

• Savings: If your savings account pays 3% interest and inflation is also 3%, your money is not growing in real terms. It is just keeping pace. If inflation is higher than your interest rate, your savings lose purchasing power, even if the balance goes up. Interest earned inside an ISA is tax free. Nothing is taken off the headline rate before you compare it with inflation.
• Wages: A 2% pay rise when inflation is 5% is effectively a pay cut. Your salary needs to at least match inflation to maintain your standard of living.
• Tax: Income tax thresholds do not rise automatically with prices. In 2026/27 the Personal Allowance is £12,570. The basic rate band still runs to £50,270. Both are unchanged from the year before. So a pay rise that only matches inflation can still push more of your income into a higher band. This is called fiscal drag. It is easier to see once you know how income tax bands and rates and National Insurance thresholds work.
• Debt: In one sense, inflation helps debtors. The real value of what you owe falls over time, because you are repaying with money that is worth slightly less. The catch is that the Bank of England usually responds to high inflation by raising rates. That pushes up the cost of variable and tracker borrowing. It is worth understanding this alongside how a UK mortgage works.
• Pensions: The State Pension rises each year by the highest of inflation, average earnings growth or 2.5%. This is called the ‘triple lock’. For April 2026 the uprating was 4.8%, driven by the earnings limb rather than inflation. That took the full new State Pension to £241.30 a week. More detail is in the guide to how the State Pension is worked out.

Where you actually feel inflation

Headline CPI is an average across a basket of around 700 goods and services. It does not describe any one household’s costs. At 18 to 25, your spending is usually skewed towards a handful of things: rent, energy, transport, phone contracts and food. If those items rise faster than the average, your personal rate of inflation is higher than the published figure. The published figure is still the right one for the economy as a whole.

Energy is the clearest example, because it is set by a separate mechanism. The Ofgem cap is reviewed every three months. It can move sharply in either direction, while headline CPI barely shifts. The guide to how the energy price cap works covers this.

Contracts are the other place inflation shows up directly. Some mobile and broadband providers write annual price rises into their terms, using CPI or RPI as the reference. Rail fare rises and student loan interest are linked to RPI rather than CPI, though for some student loan plans the interest rate is capped. RPI generally runs higher than CPI, so an RPI-linked increase tends to be the larger one.

Why does the Bank of England target 2% inflation?

The Bank of England has a government-set target to keep CPI inflation at 2%. A stable, low rate of inflation supports economic confidence. It also protects the value of savings and wages. When inflation strays too far from 2%, in either direction, the Bank adjusts the base rate to bring it back on track:

• Inflation above 2%? Raise rates. More expensive borrowing slows spending and eases upward pressure on prices.
• Inflation below 2%? Cut rates. Cheaper borrowing encourages spending, which pushes prices back up.

If inflation goes above 3% or falls below 1%, the Bank Governor must write an open letter to the Chancellor explaining why.