Inflation and Deflation: What Each Means for Your Money

Inflation is the rate at which prices are rising across the economy. Deflation is the rate at which they are falling. The UK's headline measure, the Consumer Prices Index, rose by 3.1% in the 12 months to August 2026, up from 2.9% the previous month¹. Deflation would show as a negative rate on the same measure, meaning the general price level is falling rather than rising.

The two are not mirror images in how they feel. Inflation erodes what a pound buys, and it hits households unevenly because they buy different things. Deflation raises what a pound buys, but it comes with its own problems: pay tends to stall, debts stay fixed in cash terms while incomes fall, and people delay spending in the expectation that prices will drop further. The Bank of England aims for inflation of 2%, not zero, and not deflation².

This page sets out how each is measured, what UK inflation is doing now, what falling prices would mean for savings, debts and mortgages, and where the official figures come from.

Inflation means rising prices and money that buys less

Inflation is not a form of taxation. It is a measure of how fast the prices of goods and services are rising or falling⁶. The distinction matters because the two are often confused in public debate. A politician can describe inflation as a tax, and one did:

But no one collects it, and it is not paid to the government. What inflation does is reduce the purchasing power of each pound over time.

The arithmetic is straightforward. If inflation is at 5%, people will still pay 5p more for an item that cost £1 last year, not 5p less⁶. At 3.1%, the August 2026 rate, the same item costs about £1.03. Over a single year that looks small. Over five years it compounds: the Household Costs Indices show cumulative inflation of 32.8% for high-income households and 32.7% for low-income households over the five years to June 2026⁷.

Understanding this is not universal. A financial capability survey found that the share of respondents who said they understood the impact of inflation on the value of money fell between 2005 and 2015⁸. That gap matters when prices rise quickly, because households that do not adjust their expectations can be caught out by the gap between the interest their savings earn and the rate at which prices are rising.

Inflation also has a mechanism. Higher interest rates work because they mean less money will be spent in the UK than if interest rates had not changed, which in turn lowers inflation⁹. That is the lever the Bank of England uses, and it is why the base rate and the inflation rate are discussed together.

How inflation is measured: CPI, CPIH and the annual rate

The Office for National Statistics produces three main consumer price indices: the Consumer Prices Index (CPI), the Consumer Prices Index including owner occupiers' housing costs (CPIH), and the Retail Prices Index (RPI). CPIH is the ONS's lead measure of inflation, based on economic principles¹⁰. It is the most comprehensive measure because it includes owner occupiers' housing costs and Council Tax, which are excluded from the CPI⁵.

The indices are built differently. Rates of change for CPIH and CPI are calculated from unrounded index levels, while rates of change for RPI are calculated from the rounded published indices⁵. At the level of individual price categories, the ONS uses predominantly the geometric mean for CPIH and CPI, and arithmetic means for RPI⁵. Those technical choices mean the three measures can diverge even when they are tracking the same economy.

The RPI provides estimates of inflation from 1947 onwards, with the first official release of consumer price inflation produced in January 1956⁵. The ONS publishes consumer price inflation monthly⁵, and the figures are accredited official statistics¹⁰. The RPI is still used for some purposes, including as a reference for index-linked investments alongside CPI¹¹.

The ONS also draws on alternative data sources for some categories, including rail fares, second-hand cars and much of the grocery market⁵. That reduces the reliance on manual price collection for goods where transaction data is available.

UK inflation now: 3.1% and rising again

UK CPI inflation rose to 3.1% in the 12 months to August 2026, up from 2.9% in July¹. The path over 2026 has not been smooth. Inflation was 3.3% in March 2026, fell to 2.8% in April, dropped to 2.6% in June after a temporary ceasefire in the Middle East led to lower petrol and diesel prices, then rose to 2.9% in July and 3.1% in August².

The July increase reflected the energy price cap rise that month¹². The Bank of England has projected inflation to peak at 3.2% in the fourth quarter of 2026¹³. The UK's August rate was higher than the first estimates for France (2.7%) and Germany (2.9%)¹.

The Bank of England held the base rate at 3.75% for a sixth consecutive meeting in September 2026, despite CPI inflation rising to 3.1% in August¹⁴. The base rate is set each month by the Monetary Policy Committee, with the aim of keeping inflation at about 2%¹⁵.

Inflation has not been evenly distributed. UK consumer prices in 2026 are over 30% higher than at the start of 2021¹⁶. The Household Costs Indices show that costs for low-income households (decile 2) and high-income households (decile 9) increased by 2.7% and 2.8% respectively in the year to June 2026⁷. That was the first month since March 2025 that lower-income households experienced a lower annual inflation rate than higher-income households⁷.

Deflation: when prices fall and why it is not simply good news

Deflation is a negative inflation rate: the general level of prices is falling. On the surface that sounds like good news, because each pound buys more. The difficulty is what tends to accompany it. Wages are sticky downwards, so pay rarely falls in step with prices. Debts are fixed in cash terms, so a mortgage or loan takes a larger share of a shrinking income. And households that expect prices to keep falling have an incentive to delay purchases, which reduces demand further.

The UK has not experienced sustained deflation in recent decades, but the machinery for dealing with it exists in specific places. The Pension Protection Fund states that if CPI inflation falls below 0 per cent, compensation will not be reduced¹⁷. That is a floor written into the scheme: deflation does not cut the payments.

For a saver, deflation is the mirror of inflation: cash gains purchasing power over time. For a borrower, it is the opposite. A mortgage of a fixed cash amount becomes more expensive in real terms if the income used to pay it is falling. That asymmetry is why central banks generally aim for a small positive inflation rate rather than zero.

What inflation does to your savings

The core risk is simple. If inflation is higher than the interest rate you earn, the spending power of your savings may still decrease³. A fixed-rate savings bond carries the same risk: your original investment will not hold its value in real terms if the interest you are getting is less than the rate of inflation over the investment period¹¹.

Cash savings are particularly exposed. Interest rates often fail to keep pace with inflation, meaning that cash is losing its purchasing power¹². Savings in a bank often lose value over time due to inflation, though they are very secure¹³. That trade-off between security and real return is the central one for anyone holding cash.

The picture is not uniformly bleak. As of 17 September 2026, 76% of savings accounts offered a rate higher than inflation¹⁴. That means most savers could, in principle, find an account that preserves purchasing power, though the rate on any individual account depends on its terms.

Inflation also affects behaviour. A 1 standard deviation increase in economic insecurity is associated with a 0.05 standard deviation decrease in the amount of savings in the following wave, according to research on the economic insecurity trap¹⁸. That suggests that when households feel less secure about prices and incomes, they save less, not more.

Real returns: growth after inflation

A real return is the return on an investment after inflation is taken into account. If a fund grows by 5% and inflation is 3%, the real return is roughly 2%. The gap matters over time. A £1,000 investment in a fund charging 0.1% and growing at 5% per year would be worth £1,275 after five years, while the same £1,000 in a fund charging 1% and growing at the same 5% would be worth £1,214, a gap of £61¹⁹. Costs compound just as returns do.

The official illustration of inflation erosion is the cash warning that firms must give. It includes a generic example of how inflation erosion would affect a £10,000 pot over five years, assuming 0% interest and using a measure of inflation generally accepted in the United Kingdom²⁰. The Consumer Prices Index may be used as the measure of the current inflation rate for that warning²⁰.

Real returns have been weak in recent years. Real earnings fell by 3% in the financial year 2022/23 compared with the Consumer Prices Index²¹. Since June 2023 real wages have begun rising again, at 1.4% annual growth²². The longer record shows how unusual the recent period has been: real income growth from 1994-95 to 2009-10 was five times more than the growth recorded in the following period²³.

For savers, the practical question is whether the interest rate on an account exceeds the inflation rate over the same period. For investors, it is whether the return after costs exceeds inflation. Both require looking at the real figure, not the nominal one.

Past inflation peaks and what they did to household incomes

The recent inflation episode has been unusual in how it affected different households. In the year to March 2024, the Household Costs Index showed a gap of 1.1 percentage points between high-income and low-income household inflation rates²⁵. High-income households (decile 9) saw a 5.0% rate, while low-income households (decile 2) saw 3.9%²⁵. That gap has since narrowed and, by June 2026, reversed: low-income households had a lower annual rate than high-income households for the first time since March 2025⁷.

The drivers of those differences are specific. Mortgage interest payments increased the annual rate for high-income households by 0.95 percentage points more than for low-income households in March 2024²⁵. Restaurant and hotel prices contributed 0.26 percentage points more to high-income households' inflation rate, while alcohol and tobacco made a greater contribution to low-income households' rate, at 0.12 percentage points²⁵.

Forecasts suggest the gap could widen again. The Resolution Foundation projected a gap of 0.9 percentage points by the fourth quarter of 2026, with the poorest decile facing inflation of 3.8% against 2.9% for the richest, assuming £288 rises persist²⁶. That would reverse the recent narrowing.

The longer history shows how inflation has shaped living standards. April 2024 saw an inflation-based increase in benefits of 6.7%²⁷. Benefits are uprated based on year-to-September inflation figures, with increases implemented the following April²⁸. Real incomes among the poorest fifth of households were forecast to fall by 5% in 2022-23 to 2023-24, compared with 8% for rich households²⁹.

Inflation, interest rates and your mortgage

Mortgage interest payments are a direct channel through which inflation reaches household budgets. For mortgagor households, mortgage interest payments contributed 0.54 percentage points to the annual Household Costs Index inflation rate in December 2025, down from 0.64 percentage points³⁰. The contribution varies sharply by income: in March 2024, mortgage interest payments increased the annual rate for high-income households by 0.95 percentage points more than for low-income households²⁵. In March 2025, they contributed 0.39 percentage points more to inflation for high-income households compared with low-income households³¹.

The type of mortgage matters. While rates are falling, they remain significantly higher than in the 2010s, which means that generally fixed-rate mortgages will offer a better deal¹⁵. That is a statement about the relationship between fixed and discount rates in the current environment, not a recommendation.

The Bank of England's base rate is the anchor for mortgage pricing. The base rate rose from 0.1% in December 2021 to 5.25% in August 2023³³. It was held at 3.75% in September 2026¹⁴. The Bank's statutory objective is monetary and financial stability³⁴, and it sets the base rate each month to steer inflation towards the 2% target¹⁵.

For anyone with a mortgage, the practical link is that inflation influences the base rate, which influences the cost of borrowing. When inflation rises, the expectation is that rates may rise or stay higher for longer. When inflation falls, the expectation is the reverse. The Household Costs Indices show that mortgage interest payments contributed 0.14 percentage points more to inflation for non-retired households than for retired households in June 2026⁷.

Where to find the official figures and get help

The Office for National Statistics publishes consumer price inflation monthly, and the figures are accredited official statistics¹⁰. The ONS also publishes the Household Costs Indices, which show inflation for different household groups, and the Price Index of Private Rents, which measures private rent inflation for new and existing tenancies⁴. The next CPI insurance time series release is due 21 October 2026³⁵.

For anyone trying to work out what inflation means for their own money, free and impartial help is available. MoneyHelper provides guidance on savings and cash savings bonds³⁶. The Financial Ombudsman Service can look at complaints about financial products, and in some cases the law requires a business to deduct income tax at the basic rate from compensation, whether or not you are a taxpayer³⁷. The ombudsman has awarded compensation where a bank failed to fully explain investment options³⁸.

The Financial Services Compensation Scheme protects eligible deposits and pensions. For pension scheme members, the Pension Protection Fund provides inflation-linked increases on payments for pensionable service after April 1997, up to 2.5%⁴⁰. For any pensionable service after April 1997, payments rise in line with inflation each year, up to 2.5%¹⁷.