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Why you should care about inflation

With inflation on the rise, it is worth considering how rising prices can impact your lifestyle.

Why you should care about inflation

Inflation has started to dominate the headlines once again. It’s a word you definitely shouldn’t ignore because it matters a lot, and it would be wrong to underestimate its potential impact.

So what is inflation? Quite simply, it means the increased cost of buying things, such as your weekly supermarket shop.

When we measure inflation, we are measuring how much the cost of things are either going up or down. When they go up, the value of our money doesn’t stretch as far.

It’s a straightforward concept, which impacts the spending patterns of the population.

This week, the Office of National Statistics (ONS) revealed inflation rose to 2.9% in May, up from 2.7% the month before, hitting a four-year high.

That means day-to-day items are costing you more. Explaining inflation to my housemate, she asked a fairly reasonable question; who keeps making things more expensive?

It’s not a ‘who’ exactly, as there isn't a person deciding to add 5p to your loaf of bread this month. Inflation is determined by what is happening in the economy more generally.

'Brexit' has been blamed for the latest round of price rises. Deciding to leave the European Union (EU) caused the pound to weaken against other major currencies. This is significant when you live in a country that imports a lot of goods because it reduces the purchasing power of your money.

However, the UK's planned departure from the EU isn't the only reason that prices are rising. Seasonal changes can also play a role.

The ONS pinpointed computer games and package holidays as two key drivers of inflation. If you’re going on holiday, you’ll not only have to pay more to go - but you’ll also spend more when you’re there because the exchange rate on sterling isn’t as good as it used to be. You are effectively being hit with a double whammy!

If you think you can avoid inflation by staying at home this summer and not upgrading the X-Box, you’re wrong.

Basic everyday essentials like food and energy have seen their prices rise too, the latter thanks to higher oil prices. You can’t escape inflation, I’m afraid.

It might be annoying having to shell out more for your shopping, but inflation isn’t actually considered a bad thing by economists: it can indicate that an economy is peforming well. It’s also closely correlated with employment, and as employment rises - and the number of unemployed falls - inflation has the potential to go up.

Unemployment dropped 50,000 to 1.53 million in the three months to April, which is the lowest level since records began in 1975. Meanwhile, the number of people in work hit a new high of 74.8%, which is the highgest figure since records began in 1971.

This is all good news, right? Well, sort of...

While unemployment is low and the economy hasn’t fallen apart post-Brexit as many had feared, the main problem is wages aren’t going up in line with the price of goods, hitting living standards. When someone tells you the economy is doing well, it's understandable that you may wonder why you’re not doing better.

Average earnings fell by 0.6% in real terms over the three months to April. Meaning your earnings will buy you 0.6% less when compared with the same period last year.

Inflation plus no real wage growth means our money is being ‘squeezed’. This means there are a growing number of people who feel they can’t afford their lifestyle anymore. Those who living off benefits are under even more pressure, as benefits don’t rise in line with inflation.

The Bank of England is concerned about inflation and its impact on living standards, not least because it is running above its 2% target. The Bank can try to bring inflation back under control by raising interest rates - a scenario that is becoming more likely. Members of the Bank’s Monetary Policy Committee (MPC) - who are in charge of setting interest rates - voted 5-3 to keep interest rates at their record low of 0.25% on Thursday.

While inflation is a worry, the MPC appears to be more concerned about the impact an interest rate rise would have on incomes. Rising interest rates could cause interest rates on loans, credit cards and mortgages to increase in turn.

For now, households have had a reprieve, but it’s only a matter of time before inflation forces the MPC to raise rates. It's time to prepare for this scenario.

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Barnett eyes revival and 'refines' unquoted portfolio

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