What Causes Inflation?

Inflation is the rate at which prices rise, measured over a year. UK consumer price inflation was 3.1% in the 12 months to August 2026, up from 2.9% in July, and the Bank of England's target is 2%¹. That single number is the end of a long chain: the Office for National Statistics prices a basket of goods and services, compares the total with what the same basket cost a year earlier, and publishes the difference³.

There is no single cause. Prices rise when the money in circulation grows faster than the economy can produce goods and services, when energy, fuel and rent costs climb, and when global demand or supply disruption pushes import costs up. The 2022 spike to 11.1% came from strong global demand for consumer goods, supply chain disruption and soaring energy and fuel prices⁴. The 2026 rise is a different mix, led by transport and energy feed-through.

Inflation is the rate at which prices rise, measured over a year

Inflation is a measure of how fast the prices of goods and services are rising or falling. It is not a form of taxation, though the claim that it is gets made often enough to be worth addressing directly: the phrase "Inflation is a tax, it is a tax that impacts the poorest people the most" was used by Rishi Sunak on 1 October 2023, and fact-checkers rejected the description⁷. No one collects inflation and no law imposes it. What it does do is reduce what a fixed sum of money buys, which is why it feels like a levy on households whose income does not move with prices.

The effect compounds. Over the decade to 2025, inflation increased by 22.9%⁸. That is the cumulative figure, not an annual one: prices did not rise 22.9% in a single year, they rose by that much in total across the period. A household whose income grew more slowly than that lost ground in real terms, and one whose income was fixed lost ground by the full amount.

Inflation also has a floor and a ceiling that matter. The Bank of England aims for 2%, not zero². A moderate level of inflation is healthy for the economy because it helps drive economic growth⁹. Falling prices sound attractive but are not: deflation tends to signal a recession¹⁰. The danger zone is not mild inflation but inflation that runs well above target for long enough to become embedded in wage and price setting.

How the ONS measures inflation: the basket of goods and CPI

The ONS builds a representative sample of approximately 760 goods and services, reviewed annually, and prices them at approximately 20,000 outlets within the UK³. Around 160 of those items are collected centrally rather than by field staff³. The figures are published monthly³. The basket includes over 700 items ranging from food to rents⁸.

Inflation is then calculated by comparing the cost of the basket, the level of CPI, with what it was a year ago⁹. That is the whole method in one sentence. Everything else, the weighting, the outlet sampling, the annual review of what goes in, exists to make that year-on-year comparison representative of what households actually buy.

The basket changes because spending patterns change. When the composition shifts, the measured rate shifts with it, which is why two inflation figures for the same month can differ if they use different baskets or different coverage. The Consumer Prices Index is a national index of retail prices and may be used as a measure of the current inflation rate².

What pushes prices up: money supply, energy, rents and other costs

Inflation stems from an increase in the amount of money in circulation in the economy¹¹. That is the monetary explanation, and it has a specific form: demand-pull inflation occurs when an increase in the supply of money in circulation leads to greater demand for goods and services at a rate that exceeds the economy's production capacity¹¹. When there is more money chasing the same quantity of goods, prices rise.

Cost-push works from the other direction. Energy is the clearest example. Electricity, gas and other fuels price inflation reached 9.3% in August 2025¹². Household gas prices rose 8.0% and electricity prices 2.1% in July 2026¹². The energy price cap was raised in July 2026, with feed-through into wider inflation expected later in the year¹³. The Bank of England has estimated a further percentage increase of 0.3 indirectly due to companies passing on their higher energy costs, such as from food, by the third quarter of 2026¹⁴.

Rents are the third channel. The Price Index of Private Rents measures private rent inflation for new and existing tenancies¹⁵. Mortgagor and other owners as well as social and other renters saw annual inflation rates of 4.2% and 4.1% respectively in September 2025¹⁶. Housing costs enter the measured rate differently depending on which index is used, which is one reason CPI and CPIH diverge.

Recent UK inflation: back up to 3.1%

The path over 2026 has been uneven. Inflation was 3.3% in March 2026, fell to 2.8% in April, stayed at that level for May due to slowing food price rises, rose to 2.9% in July, then reached 3.1% in August². The August figure was the second consecutive monthly rise¹.

Transport was the largest contributing division to CPI in June 2026, at 0.80 percentage points¹⁸. The UK's 3.1% was higher than the first, or flash, estimates of inflation for France (2.7%) and Germany (2.9%) in August 2026¹.

For context, the recent spike peaked at 11.1% in October 2022⁵. At the other end, CPI inflation fell to just 0.2% in August 2020 during the Covid pandemic¹⁹. It was 3.2% in the 12 months to March 2024²⁰. The Bank of England held the base rate at 3.75% on 17 September 2026, the sixth consecutive meeting at that level, despite CPI rising to 3.1% in August⁶.

How inflation affects your savings, investments and income

Cash is the most exposed. Interest rates often fail to keep pace with inflation, meaning that your cash is losing its purchasing power²¹. Savings in a bank often lose value over time due to inflation, though they are very secure²². The rule is simple: if inflation is higher than the interest rate you earn, the spending power of your savings may still decrease²³. Your original investment will not hold its value in real terms, its buying power, if the interest you are getting is less than the rate of inflation over the investment period²⁴.

The impact of inflation will reduce the buying power of your money over time unless the growth you receive through interest keeps up with the rate of price inflation²⁵. Some investments are built to track this directly: an investment can be linked to an inflation index, either CPI or RPI²⁶. Others are not. Inflation is a major risk for bonds, and over longer periods of time it may erode the return of a bond portfolio, causing the value to fall in real terms²⁷. A pension fund carries the same warning: inflation will reduce how much the fund is worth in real terms as well as how much your income is worth over the years²⁸.

The real return is the figure that matters. If an investment grows by 8% but inflation is 5%, the real return is only 3%²⁹. Return on investment is expressed as a percentage measuring the profit generated by an investment relative to its cost, but that headline percentage says nothing about purchasing power³⁰. A worked example makes the gap concrete: money in an account earning 2% interest per year while inflation was at 3% over the same time is losing ground³¹.

Income is affected too, though not uniformly. The basic State Pension increases every year by the highest of earnings growth in Great Britain, CPI price growth in the UK, or 2.5%³². That protects pension income against price rises in a way that a fixed private income is not. Among consumers whose household income decreased, 11% attributed it to inflation negatively impacting the value of household income³³.

Why a little inflation is considered healthy

A moderate level of inflation is healthy for the economy as it helps drive economic growth⁹. The Bank of England's target is 2%, set by the Government, and the Monetary Policy Committee aims to keep inflation as close as possible to that figure². The target is not zero because zero leaves no room to absorb shocks and because falling prices carry their own risks.

Deflation, a sustained fall in prices, is the mirror problem. Lower prices are not necessarily a good thing, because the reasons behind them tend to signal a recession¹⁰. A economy in which households expect prices to fall tends to defer spending, which reduces demand, which pushes prices down further.

Who sets the response, and what protects you

The base rate is set each month by the Monetary Policy Committee, with the aim of keeping inflation at about 2%¹⁴. The Government sets the target of getting inflation to 2%². The base rate was held at 3.75% on 17 September 2026⁶. The Monetary Policy Committee meets to decide that rate, and the 2% inflation target explains why the target exists and how higher interest is meant to bring prices down.

For a consumer, the practical protections are indirect. The State Pension's annual increase rule, the highest of earnings growth, CPI price growth or 2.5%, shields one major income stream from price erosion³². Index-linked investments do the same for capital²⁶. Beyond that, the protection is in what you hold: cash is secure but exposed to inflation, while investments that grow faster than prices preserve buying power at the cost of risk.

Free, impartial help on managing money when prices rise is available from MoneyHelper, and the cost of living crisis page covers what happened to prices from 2021. For the measures themselves, CPI and CPIH sets out how the two headline indices differ, and the latest UK inflation figures page tracks each monthly release.