With living costs on the up and borrowing getting more expensive, the frustration is real. Are the powerful people having a laugh or is there a method to this madness? Let’s make it make sense.

What is inflation?

Inflation is a word used by economists to describe money becoming worth less over time. They measure inflation by looking at what a certain amount of money can buy you from one year to the next. 

Inflation can be caused by a few things, but at the moment it’s all about supply and demand. Low supply and high demand, to be precise. 

The world is bouncing back from the pandemic and businesses and factories are starting to buzz again. It’s great news but they simply can’t produce things fast enough, this means the price of stuff - from food to energy - shoots up.

Why does inflation make borrowing more expensive?

The Bank of England is a central bank, not a commercial bank (somewhere you can borrow money from). They provide banking services to the UK Government, other central banks and some financial sector firms (more on this here, if you’re interested). 

You’ve probably heard of the Bank of England’s base rate or the base interest rate. This rate is what a central bank charges commercial banks for loans. These commercial banks set their own interest rates for customers, but they tend to rise and fall with the base rate set by the central bank.

The Bank of England uses their base rate to control inflation by either encouraging or discouraging people to spend money. When inflation is high, they increase the base rate - knowing that this will make commercial banks increase their interest rates - resulting in borrowing becoming more expensive for customers. If borrowing is more expensive, it’s less appealing to people so they slow down their spending and instead, save more. 

Now let’s circle back to the inflation chat about supply and demand. When people are less enthusiastic about spending, demand decreases and the price of stuff is driven down. So right now, with inflation on the rise, the Bank of England is increasing the base rate to discourage spending and put a lid on things.

What about mortgages?

Mortgages are, of course, money borrowed by people from commercial banks. This means that their interest rates are directly impacted by inflation and the base rate going up.

With interest rates, energy bills and national insurance tax rising whilst income tax thresholds freeze, things are understandably stressful. Here are our tips on the best way to handle your mortgage right now.

Let's end with some fun: Freddonomics

Whether you feel passionately about their price point or not, Cadbury’s humble Freddo is a big player in the inflation conversation. 

The chocolate frog was invented in the 1930s and brought back in 1994. They were relaunched at 10p to celebrate Cadbury’s centenary and their price wasn’t increased with inflation, until 2007. By keeping the 10p price point for so long, Cadbury’s decision to put the price up became infamous. 

By 2017, buying a Freddo would set you back 30p - a whopping 200% rise. In response to public outcry they dropped the price in 2018 to 25p, but this still represented almost double the inflation rate in the same period. If life was fair and Freddos were priced right, they would cost about 15p by now. 

There is one silver lining, Freddos have managed to swerve the consumer goods trend known as shrinkflation. This is where manufacturers make their products smaller, to maintain a price point in the face of inflation. Shockingly, an ONS study revealed that M&Ms, Maltesers and Minstrels were among 200 products that fell victim to shrinkflation between 2015-2017. *Gasps*.